US Dollar

Your feedback is important to us. Please take our client survey today. Highlights The long-term outlook for the dollar is bearish, but fresh shorts could be offside over the next one to three months. An uptick in US political uncertainty adds to our bullish dollar view over the next month. Stay short USD/JPY as a core holding for now. Beyond the near term, the Scandinavian currencies are best positioned for outperformance over the next 12 months. Silver is selling off relative to gold. Being long silver is a long-term bet that will pay handsome returns, but stand aside for now. Feature November is seasonally a good month for the dollar, and this year could well prove no exception (Chart I-1). Just a few days ago, the market consensus was that the dollar would decline irrespective of who sits in the Oval Office next year. A few days later and the market woke up to the realization that such a “heads I win, tails I win” bet rarely pans out smoothly. We have been very sympathetic to a dollar-bearish view over the long term, but as we highlighted last week, a few indicators have not passed our smell test, setting up the potential for a knee-jerk dollar rally. To add to this thesis, the rise in the greenback this week (and bloodbath in financial markets) has eerie historical echoes with the recent past. Remarkably, since the 2009 global financial crisis and the ensuing 2011 dollar bull market, the greenback has tended to stage its most powerful rallies into year-end. Chart I-2 shows that even after adjusting for the dollar uptrend over the last decade, November to January have proven to be very good months for dollar-long positions. This was particularly notable in 2009, 2011, 2014 and 2017 (Chart I-3). Chart I-1The Dollar Loves November Chart I-2The Dollar Since GFC Chart I-3The Dollar Is Oversold We are no technical experts, but could this time be different, especially given so many uncertainties clouding the investment outlook? And if so, what are other catalysts for a dollar bounce, other than those penned in report last week? What Could Be Different? Chart I-4The Dollar Rally Occurs In Two Phases Crises are rarely solved with one silver bullet. Historians can try to justify this over the last several centuries, but for the dollar call, it is instructive to simply re-examine the significant events we have lived through since the Great Financial Crisis. Enter 2008. The dollar rally occurred in two phases. The first phase prompted the US authorities to act by dropping interest rates, which dampened the rally and stimulated reflation. When the crisis proved bigger than the authorities expected, indiscriminate liquidation by financial market participants eventually prompted more action (Chart I-4). To be specific, the US first introduced swap lines with a select few central banks in December 2007 in response to the dollar crisis following the collapse of the housing market. These swap lines allowed foreign central banks to draw on dollar liquidity directly from the Federal Reserve and use this to provide credit to domestic concerns. However, from March to October 2008, the dollar soared by about 25%, since the swap lines did not include emerging markets. This prompted the Fed to expand its swap lines to include more developed-market participants and some emerging market countries. When the crisis proved bigger than the authorities expected, indiscriminate liquidation by financial market participants eventually prompted more action.  If we consider the situation today, we can all agree that the nature of the crisis is quite different from 2008, but the severity is as important, if not greater. However, similar to 2008, the Fed only has swap lines with 14 central banks. Moreover, the six-month original window is expiring. Granted, cross-currency basis swaps do not suggest any imminent danger (Chart I-5). Nevertheless, emerging market countries like South Africa, Turkey, India, Indonesia, and Russia do not have direct access to dollar liquidity from the Fed and are at risk to torpedo the dollar decline. Chart I-5No Funding Stresses For Now In short, many emerging market central banks do not have swap agreements with the US. These are countries with huge dollar liabilities that could continue to see their currencies fall, pushing up the aggregate dollar index. Developed market commodity currencies tend to be highly correlated with emerging market currencies, so this dynamic is very important for the US dollar call (Chart I-6). Meanwhile, there is a huge pool within the financial architecture unable to access funding through central bank swap lines. To be exact, around 60% of outstanding foreign exchange swaps/forwards are among non-bank financial and other institutions. Hedge funds are included in this group, and they entail a lot more credit risk than any central bank would be willing to bear. Then there is the Fed’s FIMA facility. This is a temporary repo facility for foreign and international monetary authorities (FIMA) that allows account holders to temporarily exchange their Treasury securities held with the Fed for US dollars. However, the pool of Treasury securities available to swap for US dollars has shrunk significantly. This has been on the back of slowing global trade and conscious diversification of reserves by offshore concerns (Chart I-7). Chart I-6EM And DM Currencies Chart I-7A Smaller Pool Of Treasurys To Sell The bottom line is that there is a window between a crisis and action by the Fed that could exacerbate the knee-jerk rally in the US dollar, as we have been highlighting in recent weeks. For now, there remains ample room for foreign central banks to draw on dollar liquidity (Chart I-8). As such, the dollar bounce will be an opportunity to establish fresh short positions rather than signal a renewed bull market. Chart I-8Ample Swap Liquidity Currency Positions US Dollar: A temporary dip in inflation expectations in the US will boost real rates and encourage flows back into US fixed-income assets. The drop in oil prices, which has been moving neck in neck with US inflation expectations, corroborates this view (Chart I-9). The DXY could easily touch 96 before consolidating gains. Chart I-9US Inflation Expectations Could Drop Euro: It remains unclear the disbursement of the funds from the pandemic emergency purchase program (PEPP). In the meantime, the European Central Bank stood pat today, confirming the narrative that Europe might be out of monetary bullets and fiscal policy is needed to revive animal spirits. This could cause air pocket for EUR/USD, which could touch 1.15 before rebounding. Yen: The yen is a perfect “heads I win, tails I don’t lose much bet.” Japan is one of the few countries offering positive real rates (Chart I-10). Switzerland also falls in that category. In a world that can temporarily dip into deflation, one might prefer to be in US dollars, but the yen and Swiss franc will also hold up nicely. Chart I-10Only In Japan And Switzerland Loonie: Our colleagues at the Daily Insights summarized the Bank Of Canada’s actions this week as technical and not fundamental (Chart I-11). With no real change in monetary policy, Canadian asset prices will remain dominated by global trends. The CAD has cyclical upside versus the USD, as we wrote about, but the current period of market tumult should push the loonie lower in the coming month or two. Chart I-11Canada Versus US Scandinavian currencies: The NOK and SEK have borne the brunt of the dollar decline so far and will bounce the most once reflation is back in play. We have a limit buy order on Nordic currencies should they decline further (Chart I-12). Chart I-12Dollar Seasonality Relative Value: Focus on relative value at the crosses rather than outright dollar bets. We are short the NZD/CAD, CAD/NOK and EUR/GBP as plays on relative fundamentals. EUR/GBP remains at risk of a significant selloff if we get a Brexit deal. Oil currencies: Remain long petrocurrencies versus the euro, but we are looking to use the tactical bounce in the dollar to shift to USD shorts. Silver: Short-term investors should stand aside on silver for now. The bullish thesis remains intact but volatility will rise in the short term.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data from the US have been positive: GDP recovered by 33.1% quarter-on-quarter on an annualized basis in Q3. The Markit Manufacturing PMI marginally increased from 53.2 to 53.3 in October. The services PMI also increased, from 54.6 to 56. The Chicago Fed National Activity Index declined from 1.11 to 0.27 in September. Initial jobless claims increased by 751K for the week ending on October 23rd. The DXY index increased by 1% this week alongside the equity market correction, impacted by the looming US elections and increasing number of COVID-19 cases. Our Geopolitical strategists have upgraded Trump’s odds of winning from 35% to 45%, though major opinion polls still favor a Biden victory. Our bias is that a Biden win will likely increase fiscal stimulus and decrease economic and trade policy uncertainties, which is bearish for the US dollar. Report Links: A Few Market Observations - October 23, 2020 Does The US Save Too Much Or Too Little? - October 16, 2020 Tail Risks In FX Markets - October 2, 2020 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data from the euro area have been mixed: The Markit Manufacturing PMI increased from 53.7 to 54.4 in October. However, the Services PMI declined from 48 to 46.2.  M3 money supply surged by 10.4% year-on-year in September. The Economic Sentiment Indicator was unchanged at 90.9 in October. The euro plunged by 1.4% against the US dollar this week. On Thursday, the ECB held its key interest rate unchanged at -0.5% despite re-imposed lockdown measures against surging COVID cases in Europe. However, it also hinted that there could be additional policy action and more stimulus in December should conditions worsen. Report Links: Addressing Client Questions - September 4, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data from Japan have been positive: The Jibun Manufacturing PMI increased from 47.7 to 48 in October. The Coincident Index rose from 78.3 to 79.2 in August. The Leading Economic Index also ticked up from 86.7 to 88.4. Retail trade fell by 8.7% year-on-year in September.  The Japanese yen depreciated by 0.3% against the US dollar this week amid market volatilities. With relatively higher real interest rates, a current account surplus and cheaper valuation, the Japanese yen is our favorite safe-haven currency. We continue to recommend holding the Japanese yen as a portfolio hedge for surfing election and COVID waves. On a separate note, the BoJ kept its interest rate on hold this Thursday. The Bank also weakened its economic forecast for this year but upgraded the economic recovery outlook. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data from the UK have been mixed: Retail sales increased by 4.7% year-on-year in September. The Markit Manufacturing PMI declined from 54.1 to 53.3 in October. The services PMI fell from 56.1 to 52.3 in October. The British pound plunged by 1.5% against the US dollar this week amid broad USD strength. The latest PMI releases saw a steeper decline in the services industry. As UK’s services account for more than half of total economic output, it suggests that the pound is more exposed to second infection risks than other manufacturing-oriented economies. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data from Australia have been positive: Imports fell by 1% month-on-month in September. Exports, however, increased by 3% month-on-month. The trade surplus widened from A$2.6 billion to A$5.1 billion. Headline CPI increased by 0.7% year-on-year in Q3, up from -0.3% the previous quarter. The Australian dollar fell by 1.5% against the US dollar this week. The pickup in inflation eased the RBA’s pressure to further ease monetary policy further. The expansion in the trade account surplus also bodes well for the Australian dollar in a reflationary environment. Report Links: An Update On The Australian Dollar - September 18, 2020 On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data from New Zealand have been negative:  Exports fell from NZ$4.4 billion to NZ$4 billion in September while imports expanded from NZ$4.7 billion to NZ$5 billion. The trade deficit therefore widened from NZ$282 million to NZ$1,013 million. The ANZ Business Confidence Index rose to -15.7 from -28.5 in October. The New Zealand dollar fell by 1.2% against the US dollar this week. The ANZ Activity Outlook Report said that “there was a mix of ups and downs” in recent developments and warned against higher economic and unemployment risks once the cushioning impact of the wage subsidy fades. Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data from Canada have been positive: Building permits increased by 17% month-on-month in September. The Canadian dollar plunged by 1.7% against the US dollar this week. Crude oil prices dropped by 12% this week amid worries about the second infection wave and prolonged travel restrictions, which represent a headwind for the Canadian dollar. On Wednesday, the Bank of Canada announced that it would keep interest rates on hold at 0.25% and maintain such low policy rates until the inflation objective is achieved. Moreover, the Bank is recalibrating the QE program to shift purchases towards longer-term bonds, which have a more direct influence on the borrowing rates for household and businesses. Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data from Switzerland have been negative: The ZEW Expectations Index plunged from 26.2 to 2.3 in October. Total sight deposits increased from CHF 705.1 billion to CHF 706.9 billion for the week ending on October 23rd. While the Swiss franc depreciated by 1% against the US dollar this week, it increased by 0.5% against the euro, which brings it close to our limit buy price of 1.06. An expensive currency is likely to impede growth for a small open economy like Switzerland, suggesting the SNB will step up its currency intervention. Prepare to go long EUR/CHF.  Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data from Norway have been positive: Retail sales increased by 0.3% month-on-month in September. The Norwegian krone plunged by 3.4% against the US dollar this week, making it the worst performing G10 currency. Despite recent market volatilities, we continue to favor the Norwegian krone in the long run based on its cheap valuation and a brighter energy outlook in the post-vaccine world. We are looking to rebuy the Nordic currencies on weakness. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data from Sweden have been positive: The trade balance shifted from a deficit of SEK 2.1 billion to a surplus of SEK 2.6 billion in September. Consumer confidence increased from 88.4 to 90 in October. Retail sales increased by 3.9% year-on-year in September. PPI fell by 4.2% year-on-year in September. The Swedish krona decreased by 1.9% against the US dollar this week. While COVID cases have been resurging in Sweden, Sweden’s services is lower, as a % of GDP, than other major euro area countries and therefore less exposed to the risk of a second wave. We continue to recommend the Swedish krona from a cyclical perspective. Kelly Zhong Research Analyst Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Your feedback is important to us. Please take our client survey today. Highlights Mounting populism has created a structural tailwind behind inflation. The risk that inflation accelerates quickly is greater than the market appreciates. Monetary dynamics strongly influence consumer prices when inflation is stationary. The Federal Reserve’s back-door monetization of debt is inflationary. Financial assets do not embed a sufficiently large risk premium against higher inflation. The long-term, real returns of equities are likely to be poor. Small cap stocks and commodities offer cheap protection against higher inflation. Feature The equity market is extremely vulnerable to positive inflation surprises. The expectation of an extended period of low interest rates and extraordinarily easy monetary policy is the crucial justification for the S&P 500’s exceptionally elevated multiples. Anything that could threaten this policy set up would create a danger for stocks. Whether the mean of inflation in a given period is stationary will determine the influence that money has on inflation. The problem for the S&P 500 is that investors assign a much-too-small probability to the inflation risk, especially as structural and political forces point to an elevated chance that inflation will reach 3% to 5% within the next 10 years. There is also a non-trivial probability that inflation begins rising significantly faster than the market anticipates, even if it is not BCA Research’s base case. The dichotomy between the low odds of a quick turnaround in inflation embedded in financial asset prices and the inflationary threat created by monetary and fiscal choices is too large. It will force market participants to assign a greater inflation risk premium in bonds and stocks to protect against this eventuality. This process could precipitate painful corrections in both bond and equity prices. The good news is that inflation protection remains cheap. Three Stages Of Inflation The staggering recent increase in money supply and the extraordinary fiscal stimulus rolled out this year raise two questions: Are we exiting the recent period of low and stable inflation that has prevailed? Is inflation becoming a threat to financial asset prices? Major turning points in inflation provide context to assess the risk of an impending threat of increased inflation. From a statistical perspective, three phases in inflation dynamics have defined the past 100 years (Chart I-1): Chart I-1Three Stages Of Inflation 1922 to 1965: Inflation gyrated violently from as low as -12.1% to as high as 11.9% in response to various shocks such as the Great Depression or World War II. Nonetheless, inflation’s mean was stationary or trendless. 1965 to 1998: A period of great upheaval when inflation trended strongly, moving up until 1980 and then down until 1998. 1998 to present: Inflation has been stable, flatlining between 0.6% and 2.9%. Chart I-2More Often Than Not, Money Matters Empirically speaking, whether the mean of inflation in a given period is stationary will determine the influence that money has on inflation. The era of stationary inflation from 1922 to 1965 saw M2 closely correlated with changes in US consumer prices, but the link was severed from 1965 to 1998 when inflation trended strongly (Chart I-2, top and bottom panel). When inflation stabilized again from 1998 to 2020, M2 growth again explained gyrations in consumer prices (Chart I-2, bottom panel). Why did inflation behave differently from 1965 to 1998 compared with other episodes in the past 100 years? The defining factor of the pre-1965 era was an adherence to the gold standard. The gold standard created a hard anchor on prices because its rigidity made monetary policy credible, which produced stable inflation expectations. The velocity of money was also steady. Consequently, using the Fisher formulation of the equation of exchange (Price*Output = Money*Velocity or PY=MV), inflation became a direct derivative of the money supply. Various shocks such as a war or a depression would impact the rate of expansion of money, leading to a nearly linear effect on prices. When we examine unstable inflation from 1965 to 1998, it helps if we split the period into two subsamples: 1965 to 1977 and 1977 to 1998. The first interval generated accelerating inflation due to a multitude of factors. In the mid-1960s, slack in the US economy disappeared while demand became excessive as a result of the federal government’s increased spending from The Great Society programs and the Vietnam War. Additionally, by 1965, the gold standard was under attack. The US current account disappeared between 1965 and 1969. Worried by the deteriorating US balance of payment dynamics, French President De Gaulle sent his navy to repatriate France’s gold at the New York Fed. Other countries followed suit. The continued pressure on the US balance of payments, along with the need for easier monetary policy following the 1970 recession, lead to the 1971 Smithsonian Agreement whereby President Nixon unpegged the dollar from gold, effectively killing the gold standard. Any semblance of monetary rectitude disappeared and inflation expectations began to drift up. The oil shock of 1973 fueled the inflationary dynamics and pushed inflation higher through the rest of the decade. The developments outside of monetary policy reinforced downward pressure on inflation expectations created by the Fed’s orthodoxy. The second interval began in 1977, three years before inflation peaked. This date marks the implementation of the Federal Reserve Reform Act, which modified the Fed’s mandate from only targeting full employment to full employment and stable inflation. At first, the Act had little practical impact until Paul Volker became Fed chair in 1979 and began to combat inflation. Prior to 1977, the unemployment rate was below NAIRU (the unemployment rate consistent with full employment) most of the time, the economy overheated and ultimately, inflation trended up (Chart I-3). However, since 1977, the unemployment rate has mostly been above NAIRU and the labor market has predominantly experienced excess slack. Consequently, inflation expectations re-anchored to the downside and realized inflation collapsed. Chart I-3The Effect Of The Federal Reserve Reform Act Of 1977 Chart I-4The Monetarist Fed: 1977 to 1998 The relationship between short rates and money supply provides another way to appreciate the change in monetary policy after 1977. The Fed opted for a monetarist approach (officially and unofficially) when it had to combat high realized and expected inflation. During most of the past 100 years, money supply changes and short rates were either negatively correlated or not linked at all (Chart I-4, top and second panel); however, they began to move together from 1979 to 1998 (Chart I-4, bottom panel). The Fed boosted rates to preempt the inflationary impact of faster money supply expansion, which curtailed the link between prices and M2. Between 1977 and 1998, major structural forces also pushed down inflation and severed the bond between money supply and CPI. Starting with President Reagan, a period of aggressive deregulation and union-busting increased competition and removed some pricing power from labor.1 Most importantly, the rapid widening in globalization resulted in international trade representing an ever-climbing portion of global GDP. By adding more people to the global network of supply chains, globalization further entrenched the loss of workers’ pricing power, which caused wages to lag productivity and decline as a share of national income (Chart I-5). The developments outside of monetary policy reinforced downward pressure on inflation expectations created by the Fed’s orthodoxy. In the final phase from 1998 to 2020, the stabilization of inflation reunited prices and money supply. Inflation flattened due to several factors. By 1998, 70% of the global population lived in a capitalist system (compared to market shares only 28% in 1977). Thus, most of the expansion of the global labor supply was completed. China entered the WTO only in 2001, but it had been exerting its deflationary influence for many years by stealing market share away from newly industrialized Asian economies. Additionally, following the Asian Crisis of 1997, many Asian economies (including China and Japan) elected to build large dollar FX reserves to contain their currencies versus the USD, and subsidize economic activity. This process created some stability in global goods prices and slowed the USD’s depreciation started in 2002. In response to these influences, inflation expectations stabilized in the late 1990s, creating an anchor for realized inflation (Chart I-6). Thanks to this steadiness in inflation expectations, the Phillips curve (the inverse link between wages and the unemployment rate) flattened. The economy entered a feedback loop where consistent inflation rates begat stable wages, which in turn created more stability in aggregate prices. Fluctuations in the rate of inflation became directly linked to changes in the output gap and thus, variations in demand. Importantly, the flat Phillips curve and the well-anchored inflation expectations freed the Fed to maintain easier policy during expansions and allow money supply to expand in line with money demand. Chart I-5Expanding Globalization Robbed Labor Of Its Bargaining Power Chart I-6The Anchoring Of Inflation Expectations   Bottom Line: The correlation between inflation and M2 growth since 1998 is as relevant as it was from 1922 to 1965. What The Future Holds Structurally, inflation will likely trend higher. The Median Voter Theory (MVT), developed by Anthony Downs and upheld by our Geopolitical Strategy service as the key constraint on global and US policymakers, is at the heart of our position. Over the past 40 years, income and wealth inequalities have soared worldwide, especially in the US and the UK, which have both embraced ‘laissez-faire’ capitalism enthusiastically. Moreover, these countries also suffer from pronounced levels of intergenerational social immobility.2 The effect of these aforementioned trends has become so pervasive that life expectancy for a large swath of the US population is decreasing (Chart I-7). The shift by median voters to the left on economic matters will force greater fiscal profligacy and regulatory rigidity. This policy mix will add a secular drift to inflation. In response to widening inequalities, voter preferences have shifted to the left on economic matters and toward populism. Brexit and the election of President Trump both fit this pattern because they represent the repudiation of the prevalent neoliberal discourse that pushed toward more globalization, more immigration and more deregulation. Moreover, voters in the UK and the US increasingly doubt the benefits of free trade (Chart I-8). Chart I-7Inequalities Are Physically Hurting Many US Voters Chart I-8Free Trade Is Out…   Attitudes toward the government’s role in the economy have also changed. Voters in the US are much more open than they were 10 or 20 years ago to a greater involvement of the public sector in the economy. Additionally, support toward socialism has become more widespread among various demographic groups (Chart I-9). The MVT posits that politicians who want to access or remain in power must cater to voter preferences. Hence, when compared with the Great Financial Crisis, the swift fiscal policy easing that accompanied the COVID-19 recession illustrates the understanding by politicians that spending is popular, especially in times of crisis (Chart I-10). Chart I-9…But State Intervention Is In Chart I-10Politicians Deliver What Voters Want   Greater government spending and larger fiscal deficits are used to achieve faster nominal growth. When the output gap is negative, public spending helps the economy and may even increase national savings. However, if profligacy continues after the economy has reached full employment, it generates excess demand relative to aggregate supply and puts downward pressure on the national savings rate. This is inflationary. To redistribute income toward the middle class, populists aim to diminish competition in the economy. They reregulate the economy, which indirectly protects workers. They also limit global trade flows as much as possible. Free trade is good for the economy, but it puts downward pressure on the price of goods relative to services. Therefore, to remain competitive domestic goods producers must compress their labor costs, which either hurts wages for middle-class workers or destroys the number of manufacturing jobs with high wages. Undoing this process raises labor costs and undermines a major deflationary influence on the economy. Tax policy is another tool to force a redistribution of income and wealth toward the middle class. We should expect increased taxes on higher-income households. This process puts more money in the pockets of a middle class whose marginal propensity to consume is around 95% to 99% compared with 50% to 60% for households at the top of the income distribution. Re-shuffling the composition of national income toward the middle class will boost demand and puts upward pressure on consumer prices. Central banks are not immune to the preference of the median voter. As we showed earlier, the Fed Reform Act of 1977 had a meaningful impact on inflation, but only after Volcker took the helm of the FOMC. Given the damages wrought by high inflation in the 1970s, the median voter wanted to see less inflation, which enabled Volcker’s hawkish shift. As Marko Papic argued in a recent BCA Research webcast,3 a minority of voters (and policymakers) remember the pain created by inflation, but everyone is aware of the difficulties created by low nominal growth. Moreover, the Fed is still a creature of Congress and the median voter’s preferences greatly affect the legislative body’s decisions. Consequently, the Fed’s policy stance will likely become structurally looser in response to indirect voter pressure. Inflation accelerates when the Fed expands money supply faster than the federal government sucks in liquidity via its deficit. The Fed’s recent adoption of an average inflation mandate fits within this paradigm. According to its new strategy, the Fed will start tightening policy after the unemployment gap has closed and inflation is above 2%. This is reminiscent of the model prior to 1977 (when full employment conditions were paramount), which generated a significant inflation upside. Bottom Line: The shift by median voters to the left on economic matters will force greater fiscal profligacy and regulatory rigidity. It will also contribute to a more dovish bias by central banks. This policy mix will add a secular drift to inflation. What About Now? Markets may be failing to recognize the risk that inflation will rise sooner rather than later. Low yields, subpar inflation expectations, dovish central bank pricing and the valuation premium of growth relative to value stocks already reflect the strong deflationary force created by a deeply negative output gap. Thus, a quicker-than-expected recovery in inflation threatens the financial markets. Our structural inflation view is not the source of this danger. The hidden, near-term inflationary risk arises because we are still in an environment where broad money matters because inflation remains stationary. M2 is expanding at 23.7%, its fastest rate on record. If relationships of the past 20-plus years hold, then this is a warning sign for inflation. The catalyst to crystalize the structural inflationary pressures created by economic populism may be the loose monetary and fiscal conditions caused by the COVID-19 recession. Chart I-11The Real Near-term Inflation Risk This view may seem simplistic in light of the current large output gap, but when fiscal policy is included in the assessment, the picture becomes clearer. Since 1998, the gap between the expansion of M2 and the issuance of debt to the public by the federal government has explained inflation better than broad money alone (Chart I-11). Inflation accelerates when the Fed expands money supply faster than the federal government sucks in liquidity via its deficit. However, inflation decelerates when the Fed expands the money supply slower than the public sector pulls in private funds. In other words, if the Fed eases monetary conditions enough to finance the deficit, then debt monetization occurs, the private sector is not crowded out and demand gets a massive boost. This point is crucial and feeds the stronger economic recovery compared with the one post-GFC. In 2009 and 2010, the private sector was deleveraging and commercial banks were retrenching their lending. Neither the demand for nor the supply of credit was ample. Therefore, the Fed’s rapid balance sheet expansion had a limited impact on broad money. Instead, it skewed the composition of M2 toward commercial bank excess reserves at the Fed and away from private-sector deposits. Broad money was not rising quickly enough to fully finance the government and real interest rates did not fall as far as they should have. The economy suffered. A virtuous cycle has emerged, one which creates more inflation risks than are priced in. Nowadays, broad money responds much better to the Fed’s intervention because the balance sheets of the nonfinancial private sector are much healthier than in 2008 and deleveraging is absent. This mitigates the tightening credit standards of commercial banks. As Chart I-12 illustrates, household net worth is more robust than it was 12 years ago, debt-servicing costs account for a much narrower slice of disposable income and the government’s aggressive actions have bolstered household finances. Moreover, the majority of job losses have been concentrated in low-income jobs, thus, above-average earners have kept their incomes. Under these conditions, households have taken advantage of record low mortgage rates to purchase real estate, which is contributing to growth in the residential sector (Chart I-13, top two panels). Meanwhile, the rapid rebound in businesses’ capex intentions (which even small firms exhibit) and in core capital goods orders indicates that animal spirits are much more vigorous than anyone expected this past spring (Chart I-13, bottom two panels). At that time, the dominant narrative posited that firms were tapping their credit lines to set aside cash. Chart I-12Robust Household Balance Sheets = No Liquidity Trap Chart I-13Housing And Capex Are In The Driver's Seat   Chart I-14Unlike In 2008/09, Real Rates Have Collapsed Thanks to these more favorable balance sheet dynamics, the Fed’s injection of liquidity is boosting M2 enough to finance the Treasury’s issuance. Hence, real interest rates are much lower than in 2009/10 even if the economy is recovering much more quickly (Chart I-14). Policymakers are not crowding out the private sector. A virtuous cycle has emerged, one which creates more inflation risks than are priced in. A counterargument is that technology is too deflationary for the above dynamics to matter. The reality is that technology is always a deflationary force. The expansion of the capital stock has always been about providing each worker with access to newer and better technology to boost productivity. The current low level of productivity gains suggests that the dominant discourse exaggerates the economic advances from new technologies. Thus, inflation stationarity and the interplay between monetary and fiscal policy still matters to CPI. Investors should monitor factors that would indicate if the upside risk to near-term inflation described above is morphing into reality. Doing so would seriously damage financial asset prices made vulnerable to higher inflation by prohibitive valuations. We propose tracking the following variables: The household savings rate. If savings normalize faster because consumer confidence firms, then spending will accelerate, profits will rise more quickly and money will expand further, all of which will bring back inflation sooner. A Blue Sweep in the US presidential election. If the Democrats take control of both the executive and legislative branches, then they will expand stimulating policies that will bolster demand. This, too, would boost profits and broad money supply, which would be inflationary. The velocity of money. An increase in money velocity, which remains depressed, would accentuate the impact of rapid money growth. It would also suggest that animal spirits are strengthening, which will further encourage economic transactions. A weak dollar. The dollar is set to weaken because of savings dynamics and the global recovery. A runaway decline in the USD would indicate that the interplay between monetary and fiscal policy is debasing money, unleashing an inflationary spiral.  Bottom Line: The probability that inflation returns quickly is much more meaningful than financial markets appreciate because of the interplay between money growth, fiscal deficits and robust private-sector balance sheets. This dissonance will create a substantial risk for asset prices next year. Investment Implications The most important implication of the analysis above is that investors should consider inflation protection in all asset classes. However, this protection is cheap to acquire because investors are focusing on deflation, not inflation. Chart I-15Inflation Protection Remains Cheap Bonds Our bond strategists recently moved to a below-benchmark duration in fixed-income portfolios in light of the economic recovery and the increasing probability of a Blue Wave on November 3, an argument highlighted in the Section II Special Report written by our colleagues Rob Robis and Ryan Swift. The Fed’s new average-inflation target, coupled with the global economic recovery, should put upward pressure on inflation breakeven rates, which are still well below 2.3%-2.5% normally associated with stable inflation near 2% (Chart I-15). The underestimated upward risk to inflation further favors climbing yields. Beyond lifting inflation breakeven rates, this risk would also raise inflation uncertainty, which warrants a greater term premium and a steeper yield curve (Chart I-16). Additionally, higher inflation would occur lockstep with declining savings. The recent surge in excess savings was a primary driver of the collapse in yields; its reversal would push up long-term interest rates (Chart I-17). Chart I-16Rising Inflation Uncertainty Will Steepen The Yield Curve Chart I-17Excess Savings Will Fall And Yields Will Rise   The Dollar The US dollar is the major currency most exposed to growing populism because of the extraordinary income inequalities observed in the US. Moreover, a generous combined monetary and fiscal policy setting in the US has eroded the dollar’s appeal as the country’s trade deficit widens (it normally narrows during a recession) in response to pronounced national dissaving (Chart I-18, left panel). Furthermore, US broad money growth stands far above that of other major economies (Chart I-18, right panel). Compared with other major central banks, the Fed is more guilty of financing the public-sector’s debt binge. Debt monetization creates a real risk to a stable USD. Chart I-18AFalling Savings And The Fed's Generosity Will Tank The Greenback Chart I-18BFalling Savings And The Fed’s Generosity Will Tank The Greenback   The expanding global recovery creates an additional problem for the countercyclical dollar. China’s role is particularly important in this regard as the nation’s domestic economic activity will improve further in response to the lagged impact of a rapid climb in total social financing (Chart I-19, top panel). Sturdy Chinese demand results in climbing global industrial production, which will hurt the greenback. Likewise, China’s healthy recovery has lifted interest rate differentials in favor of the yuan (Chart I-19, bottom panel). A strong CNY flatters China’s purchasing power abroad and diminishes deflationary pressures around the world. This combination should stimulate the global manufacturing sector, which benefits foreign economies more than it does the US.  Investors should consider inflation protection in all asset classes. Equities BCA Research still prefers global equities to bonds on a cyclical basis. The early innings of a pickup in inflation would solidify this bias. Our Adjusted Equity Risk Premium, which accounts for the expected growth rate of earnings and the non-stationarity of the traditional ERP, shows a solid valuation cushion in favor of stocks (Chart I-20). Moreover, forward earnings for the S&P 500 have upside, judging by the gap between the Backlog of Orders and the Customer Inventories components of the ISM Manufacturing survey (Chart I-21). Chart I-19China's Robust Growth Hurts The Dollar Chart I-20The Adjusted ERP Still Favors Stocks   We also continue to overweight cyclical sectors over defensive ones. The existence of greater inflation risk than the market believes confirms this view. Cyclicals would outperform if investors priced in quicker inflation because they would also bid down the dollar and push up inflation breakeven rates (Chart I-22). These relationships exist because industrials and materials enjoy greater pricing power in an inflationary environment and financials would benefit from a steeper yield curve. An outperformance of deep cyclicals relative to defensive equities should result in an underperformance of US shares relative to the rest of the world. Chart I-21Earnings Revisions Have Upside Chart I-22Deep Cyclicals Will Like The Brand New World   The long-term outlook for real stock returns is poor, despite a positive six- to nine-month view. Higher inflation will force a greater upside in yields. However, the current extraordinary market multiples can only be justified if one believes that yields will stay depressed for many more years. Thus, inflation would likely prompt a de-rating of equities. Furthermore, our structural inflation view rests on the imposition of populist economic policies. A move backward in globalization and redistributionist policies would lift the share of wages in national income, which would compress extraordinarily wide profit margins (Chart I-23). Therefore, real long-term profits will probably suffer. Paradoxically, nominal stock prices may still eke out positive nominal gains, but that will be a consequence of the money illusion created by higher inflation. Chart I-23Populism Threatens Profit Margins BCA Research still prefers global equities to bonds on a cyclical basis. Investors should continue to overweight equities versus bonds, despite pronounced hurdles to long-term, real returns in stocks. Historically, periods of transition from low inflation to higher inflation have allowed stocks to outperform bonds, even if equities generate negative real returns (Table I-1). The exceptionally low real yields and thin inflation protection offered by government bonds increases the likelihood that history will be repeated. Table I-1Rising Inflation: Equities Beat Bonds A size bias may offer some protection against higher inflation both in the near and long term. We have been positive on small cap equities since September and our US Equity Strategy service upgraded the Russell 2000 to overweight this week.4 A bump in railroad freight volumes augurs well for the domestic economy to which small caps are very sensitive. Additionally, stronger railroad freight volumes also indicate net rating upgrades for junk bonds, which decreases the riskiness of a highly levered small cap sector (Chart I-24). Moreover, small cap stocks are positively linked to major trends produced by higher inflation, such as a weaker dollar and higher commodity prices (Chart I-25). Small firms also enjoy rising consumer confidence, a variable targeted by populist politicians (Chart I-26). Therefore, the potential for a re-rating of the Russell 2000 relative to the S&P 500 is elevated, especially if investors reassess the likelihood of higher inflation.  Chart I-24Small-Cap Stocks Are Set To Shine Chart I-25Small-Cap Will Enjoy Higher Inflation... Chart I-26...And Populists Commodities BCA Research remains positive on the prices of natural resources on a cyclical basis even if there is more risk of a near-term correction for this asset class. Commodities are highly sensitive to a global industrial cycle that offers significant upside and to China in particular. Moreover, commodities are high-beta plays on a weaker dollar and higher inflation expectations (Chart I-27). Natural resources will benefit from economic populism because it lifts demand for cyclical spending. Moreover, commodities are natural hedges against the risk of higher inflation. In this context, it makes sense to allocate more funds to resource stocks to protect an equity portfolio against inflation. Investors worried about the near-term outlook for commodities should rotate out of copper into crude. Copper has withstood the COVID-19 shock much better than Brent despite the strong cyclicality of both natural resources. Following this move, net speculative positions and sentiment measures for copper are toward the top of their ranges of the past 15 years. Meanwhile, the opposite is true for oil. Since 2005, increases in the Brent-to-copper ratio have followed declines to the current levels in the relative Composite Sentiment Indicator (Chart I-28), which includes sentiment and positioning measures for both commodities. Chart I-27Commodities Remain Efficient Inflation Hedges Chart I-28A Contrarian Tactical Trade: Buy Brent / Sell Copper   Fundamentals also point in that direction. After collapsing in recent months, global inventories of copper are beginning to climb relative to Brent. Moreover, oil production has dropped significantly relative to copper. Oil demand fell even more dramatically than that of copper, but the gap between production and demand growth is moving in favor of crude. Real long-term profits will probably suffer. This trade is agnostic to the direction of the business cycle. Copper prices embed a much more optimistic take toward global economic activity than Brent. Therefore, copper is more vulnerable to a negative economic upset than oil and less likely to benefit from a positive economic surprise. Mathieu Savary Vice President The Bank Credit Analyst October 29, 2020 Next Report: November 30, 2020   II. Beware The Bond-Bearish Blue Sweep US Election & Duration: We estimate that there is an 72% probability of a US election result that will give a lift to US Treasury yields via increased fiscal stimulus. Those are strong enough odds to justify a move to a below-benchmark cyclical US duration stance on a 6-12 month horizon. US Treasuries: We anticipate a moderate bear market in US Treasuries to unfold during the next 6-12 months. In addition to below-benchmark portfolio duration, investors should overweight TIPS versus nominal Treasuries, hold nominal and real yield curve steepeners, and hold inflation curve flatteners. Non-US Country Allocation: Within global government bond portfolios, downgrade the US to underweight. Favor countries that have lower sensitivity to rising US Treasury yields with central banks that are likely to be more dovish than the Fed in the next few years. That means increasing allocations to core Europe and Japan, while reducing exposure to Canada and Australia. Stay neutral on the UK given the near-term uncertainties over the final Brexit outcome. With the US presidential election just two weeks away, public opinion polls continue to show that Joe Biden is the favorite to win the White House. However, the odds of a “Blue Sweep” - combining a Biden victory with the Democratic Party winning control of both the US Senate and House of Representatives - have increased since the end of September according to online prediction markets. US Treasury yields have also moved higher over that same period (Chart II-1), which we interpret as the bond market becoming more sensitive to the likelihood of a major increase in US government spending under single-party Democratic control. Chart II-1A Blue Sweep Is Bond Bearish Table II-1A Comparison Of The Candidates' Budget Proposals According to a recent analysis done by the Committee for a Responsible Federal Budget, President Trump’s formal policy proposals would increase US federal debt by $4.95 trillion between 2021 and 2030, while Biden’s plan would increase the debt by $5.60 trillion (Table II-1).5 While those are both massive fiscal stimulus plans, there is a stark difference in the policy mix of their proposals that matters for the future path of US bond yields. Under Biden, spending is projected to increase by a cumulative $11.1 trillion, partially offset by $5.8 trillion in revenue increases and savings with the former vice-president calling for tax hikes on corporations and high-income earners. On the other hand, Trump’s plan includes $5.45 trillion of spending increases and tax cuts over the next decade, offset by $0.75 trillion in savings. Conclusion: Biden would increase spending by over twice that of a re-elected Trump, with much of that spending expected to be front-loaded in the early part of his first term. Outright spending is more reflationary than tax cuts because it puts more money in the pockets of consumers (spenders) relative to producers (savers). The Biden plan would be more stimulating for overall activity even if the increase in debt is about the same. Chart II-2The Biden Platform Is Highly Stimulative Another analysis of the Biden and Trump platforms was conducted by Moody’s in September, based on estimates of how much of each candidate’s promises could be successfully implemented under different combinations of White House and Congressional control.6 The stimulus figures were run through the Moody’s US economic model, which is similar to the budget scoring model of the US Congressional Budget Office, to produce a year-by-year path for the US economy over the next decade (Chart II-2). Moody’s concluded that the US economy would return to full employment in the second half of 2022 under a President Biden – especially if the Democrats win the Senate - compared to the first half of 2024 under a re-elected President Trump. Such a rapid closing of the deep US output gap that opened up because of the COVID-19 recession would likely trigger a reassessment of the Fed’s current highly dovish policy stance. At the moment, the US overnight index swap (OIS) curve discounts one full 25bp Fed hike by late 2023/early 2024, and two full hikes by late 2024/early 2025 (Chart II-3). This pricing of the future path of interest rates has occurred even with the Fed promising to keep the funds rate anchored near 0% until at least the end of 2023. The likelihood of some form of increased fiscal spending after the election will cause the bond market to challenge the Fed’s current forward guidance even more, putting upward pressure on Treasury yields. Chart II-3US Fiscal Stimulus Will Pull Forward Fed Liftoff Our colleagues at BCA Geopolitical Strategy see a Blue Sweep as the most likely outcome of the US election, although their forecasting models suggest that the race for control of the Senate will be much closer than the Biden vs Trump battle (there is little chance that control of the House of Representatives would switch back to the Republicans).7 Their scenarios for each of the White House/Senate combinations, along with their own estimated probability for each, are the following: Biden wins in a Democratic sweep: BCA probability = 27%. The US economy will benefit from higher odds of unfettered fiscal stimulus in 2021, although financial markets will simultaneously have to adjust for the negative shock to US corporate earnings from higher taxes and regulation. Government bond yields should rise on the generally reflationary agenda. Trump wins with a Republican Senate: BCA probability = 23%. In this status quo scenario, a re-elected President Trump would still face opposition from House Democrats on most domestic economic issues, forcing him to tilt towards more protectionist foreign and trade policies in his second term. Fiscal stimulus would be easy to agree, though not as large as under a Democratic sweep. US Treasury yields would rise, but would later prove volatile due to the risk to the cyclical recovery from a global trade war, as Trump’s tariffs will not be limited to China and could even affect the European Union. Biden wins with the Senate staying Republican: BCA probability = 28%. This is ultimately the most positive outcome for financial markets - reduced odds of a full-blown trade war with China, combined with no new tax hikes. Bond yields would drift upward over time, but not during the occasional fiscal battles that would ensue between the Democratic president and Republican senators. The first such battle would start right after the election. Treasuries would remain well bid until financial market pressures forced a Senate compromise with the new president sometime in H1 2021. Trump wins with a Democratic Senate: BCA probability = 22%. This is the least likely scenario but one that could produce a big positive fiscal impulse. Trump is a big spender and will veto tax hikes, but will approve populist spending on areas where he agrees. The Democratic Senate would not resist Trump’s tough stance on China, however, thus keeping the risk of US-China trade skirmishes elevated. This is neutral-to-bearish for US Treasuries, depending on the size of any bipartisan stimulus measures and Trump’s trade actions. The key takeaway is that the combined probability of scenarios that will put upward pressure on US Treasury yields is 72%, versus a 28% probability of a more bond-neutral outcome. That is a bond-bearish skew worth positioning for by reducing US duration exposure now, ahead of the November 3 election. Of this 72%, 45 percentage points come from scenarios in which President Trump would remain in power. Hence his trade wars would eventually undercut his reflationary fiscal policy. This would become the key risk to the short duration view after the initial market response. Bottom Line: The most likely scenarios for the US election will give a cyclical lift to US Treasury yields via increased fiscal stimulus. This justifies a move to a below-benchmark US duration stance on a 6-12 month horizon. If Trump is re-elected, the timing of Trump’s likely return to using broad-based tariffs will have to be monitored closely. A Moderate Bear Market While our anticipated Blue Sweep election outcome will lead to a large amount of fiscal spending in 2021 and beyond, we anticipate only a modest increase in bond yields during the next 6-12 months. In terms of strategy, our recommended reduction in portfolio duration reflects the fact that fiscal largesse meaningfully reduces the risk of another significant downleg in bond yields and strengthens our conviction in a moderate bear market scenario for bonds. This does raise the question of how large an increase in US Treasury yields we expect during the next 6-12 months. We turn to this question now. Chart II-4Less Election-Day Upside Than In 2016 Not Like 2016 First, we do not expect a massive election night bond rout like we saw in 2016 (Chart II-4). For one thing, the Fed was much more eager to tighten policy in 2016 than it is today, and it did deliver a rate hike one month after the Republicans won the House, Senate and White House (Chart II-4, bottom panel). This time around, the Fed has made it clear that it will wait until inflation is running above its 2% target before lifting rates off the zero bound and will not respond directly to expectations for greater fiscal stimulus. Second, 2016’s election result was mostly unanticipated. This led to a dramatic adjustment in market prices once the results came in. The PredictIt betting market odds of a “Red Sweep” by the Republicans in 2016 were only 16% the night before the election. As of today, the betting markets are priced for a 58% chance of a Blue Sweep in 2020. Unlike in 2016, bonds are presumably already partially priced for the most bond-bearish election outcome. A Slow Return To Equilibrium To more directly answer the question of how high bond yields can rise, survey estimates of the long-run (or equilibrium) federal funds rate provide a useful starting point. In a world where the economy is growing at an above-trend pace and inflation is expected to move towards the Fed’s target, it is logical for long-maturity Treasury yields to settle near estimates of the long-run fed funds rate. Indeed, this theory is borne out empirically. During the last two periods of robust global economic growth (2017/18 & 2013/14), the 5-year/5-year forward Treasury yield peaked around levels consistent with long-run fed funds rate estimates (Chart II-5). As of today, the median estimates of the long-run fed funds rate from the New York Fed’s Survey of Market Participants and Survey of Primary Dealers are 2% and 2.25%, respectively. In other words, a complete re-convergence to these equilibrium levels would impart 80 – 100 bps of upward pressure to the 5-year/5-year forward Treasury yield. We expect this re-convergence to play out eventually, but probably not within the next 6-12 months. In both prior periods when the 5-year/5-year forward Treasury yield reached these equilibrium levels, the Fed’s reaction function was much more hawkish. The Fed was hiking rates throughout 2017 & 2018 (Chart II-5, panel 4), and the market moved quickly to price in rate hikes in 2013 (Chart II-5, bottom panel). The Fed’s new dovish messaging will ensure that the market reacts less quickly this time around. Also, continued curve steepening will mean that the 5-year/5-year forward yield’s 80 – 100 bps of upside will translate into significantly less upside for the benchmark 10-year yield. The 10-year yield and 5-year/5-year forward yield peaked at similar levels in 2017/18 when the Fed was lifting rates and the yield curve was flat (Chart II-6). But, the 10-year peaked far below the 5-year/5-year yield in 2013/14 when the Fed stayed on hold and the curve steepened. Chart II-5How High For Treasury Yields? Chart II-6Less Upside In 10yr Than In 5y5y   The next bear move in bonds will look much more like 2013/14. The Fed will keep a firm grip over the front-end of the curve, leading to curve steepening and less upside in the 10-year Treasury yield than in the 5-year/5-year forward. In addition to shifting to a below-benchmark duration stance, investors should maintain exposure to nominal yield curve steepeners. Specifically, we recommend buying the 5-year note versus a duration-matched barbell consisting of the 2-year and 10-year notes (Chart II-6, bottom panel).8 TIPS Versus Nominals We have seen that a full re-convergence to “equilibrium” implies 80 – 100 bps of upside in the 5-year/5-year forward nominal Treasury yield. Bringing TIPS into the equation, we have also observed that long-maturity (5-year/5-year forward and 10-year) TIPS breakeven inflation rates tend to settle into a range of 2.3 – 2.5 percent when inflation is well-anchored and close to the Fed’s target (Chart II-7). The additional fiscal stimulus that will follow a Blue Sweep election makes it much more likely that the economic recovery will stay on course, leading to an eventual return of inflation to target and of long-maturity TIPS breakeven inflation rates to a 2.3 – 2.5 percent range. However, as with nominal yields, this re-convergence will be a long process whose pace will be dictated by the actual inflation data. To underscore that point, consider that our Adaptive Expectations Model of the 10-year TIPS breakeven inflation rate – a model that is driven by trends in the actual inflation data – has the 10-year breakeven rate as close to fair value (Chart II-8).9 This fair value will rise only slowly over time, alongside increases in actual inflation. Chart II-7Overweight TIPS Versus Nominals Chart II-8Real Yields Have Likely Bottomed   All in all, we continue to recommend an overweight allocation to TIPS versus nominal Treasuries. TIPS breakeven inflation rates will move higher during the next 6-12 months, but are unlikely to reach our 2.3 – 2.5 percent target range within that timeframe. TIPS In Absolute Terms As stated above, we expect nominal yields to increase more than real yields during the next 6-12 months, but what about the absolute direction of real (aka TIPS) yields? Here, our sense is that real yields have also bottomed. If we consider the extreme scenario where the 5-year/5-year forward nominal yield returns to its equilibrium level and where long-maturity TIPS breakeven inflation rates return to our target range, it implies about 80 bps of upside in the nominal yield and 40 bps of upside in the breakeven. This means that the 5-year/5-year real yield has about 40 bps of upside in a complete “return to equilibrium” scenario. While we don’t expect this “return to equilibrium” to be completed within the next 6-12 months, the process is probably underway. The only way for real yields to keep falling in this reflationary world is for the Fed to become increasingly dovish, even as growth improves and inflation rises. After its recent shift to an average inflation target, our best guess is that Fed rate guidance won’t get any more dovish from here. Real yields fell sharply this year as the market priced in this change in the Fed’s reaction function, but the late-August announcement of the Fed’s new framework will probably mark the bottom in real yields (Chart II-8, bottom panel).10 Chart II-9Own Inflation Curve Flatteners And Real Curve Steepeners Two More Curve Trades In addition to moving to below-benchmark duration, maintaining nominal yield curve steepeners and staying overweight TIPS versus nominal Treasuries, there are two additional trades that investors should consider in order to profit from the reflationary economic environment. The first is inflation curve flatteners. The cost of short-maturity inflation protection is below the cost of long-maturity inflation protection, meaning that it has further to run as inflation returns to the Fed’s target (Chart II-9). In addition, if the Fed eventually succeeds in achieving a temporary overshoot of its inflation target, then we should expect the inflation curve to invert. Real yield curve steepeners are in some ways the mirror image of inflation curve flatteners. Assuming no change in nominal yields, the real yield curve will steepen as the inflation curve flattens. But what makes real yield curve steepeners look even more attractive is that increases in nominal yields during the next 6-12 months will be concentrated in long-maturities. This will impart even more steepening pressure to the real yield curve. Investors should continue to hold inflation curve flatteners and real yield curve steepeners. Bottom Line: We anticipate a moderate bear market in US Treasuries to unfold during the next 6-12 months. In addition to below-benchmark portfolio duration, investors should overweight TIPS versus nominal Treasuries, hold nominal and real yield curve steepeners, and hold inflation curve flatteners. Non-US Government Bonds: Reduce Exposure To US Treasuries The mildly bearish case for US Treasuries that we have laid out above not only matters for our recommended duration stance, but also for our suggested country allocation within global government bond portfolios. Simply put, the risk of rising bond yields is much higher in the US than elsewhere, both for the immediate post-election period but also over the medium-term. Thus, the immediate obvious portfolio decision is to downgrade US Treasuries to underweight. The move higher in US Treasury yields that we expect is strictly related to spillovers from likely US fiscal stimulus. While other countries in the developed world are contemplating the need for additional fiscal measures, particularly in Europe where there is a renewed surge in coronavirus infections and growing economic restrictions, no country is facing as sharp a policy choice as the US with its upcoming election. We can say with a fair degree of certainty that the US will have a relatively more stimulative fiscal policy stance than other developed economies over at least the next couple of years. This implies a higher relative growth trajectory for the US that hurts Treasuries more on the margin than non-US government debt. In addition, the likely path of relative monetary policy responses are more bearish for US Treasuries. As described above, the scope of the US stimulus will cause bond investors to further question the Fed’s commitment to keeping the funds rate unchanged for the next few years. That also applies to the Fed’s other policy tools, like asset purchases. The Fed is far less likely to continue buying US Treasuries at the same aggressive pace it has for the past eight months if there is less need for monetary stimulus because of more fiscal stimulus. Chart II-10The Fed Will Gladly Trade Less QE For More Fiscal Stimulus According to the IMF, the Fed has purchased 57% of all US Treasuries issued since late February of this year, in sharp contrast to the ECB and Bank of Japan that have purchased over 70% of euro area government bonds and JGBs issued (Chart II-10). If US Treasury yields are rising because of improving US growth expectations, fueled by fiscal stimulus, the Fed will likely tolerate such a move and buy an even lower share of Treasuries issued – particularly if the higher bond yields do not cause a selloff in US equity markets that can tighten financial conditions and threaten the growth outlook. The fact that US equities have ignored the rise in Treasury yields seen since the end of September may be a sign that both bond and stock investors are starting to focus on a faster trajectory for US growth. In terms of country allocation, beyond downgrading US Treasuries to underweight, we recommend upgrading exposure to countries that are less sensitive to changes in US Treasury yields (i.e. countries with a lower yield beta to changes in US yields). In Chart II-11, we show the rolling beta of changes in 10-year government bond yields outside the US to changes in 10-year US Treasury yields. This is a variation of the “global yield beta” concept that we have discussed in the BCA Research bond publications in recent years. Here, we modify the idea to look at which countries are more or less correlated to US yields, specifically. A few points stand out from the chart: Chart II-11Reduce Exposure To Bond Markets More Correlated To UST Yields All countries have a “US yield beta” of less than 1, suggesting that Treasuries are a consistent outperformer when US yields fall and vice versa. This suggests moving to underweight the US when US yields are rising is typically a winning strategy in a portfolio context. The list of higher beta countries includes Canada, Australia, New Zealand, the UK and Germany; although Canada stands out as having the highest yield beta in this group. The list of lower beta countries includes France, Italy, Spain, and Japan. In Chart II-12, we show what we call the “upside yield beta” that is estimated only using data for periods when Treasury yields are rising. This gives a sense of which countries are more likely to outperform or underperform during a period of rising Treasury yields, as we expect to unfold after the election. From this perspective, the “safer” lower US upside yield beta group includes the UK, France, Germany and Japan. The riskier higher US upside yield beta group includes Canada, Australia, New Zealand, Italy and Spain. Chart II-12Favor Bond Markets Less Correlated to RISING UST Yields Spain and Italy are less likely to behave like typical high-beta countries as US yields rise, however, because the ECB is likely to remain an aggressive buyer of their government bonds as part of their asset purchase programs over the next 6-12 months. We also do not recommend trading UK Gilts off their yield beta to US Treasuries in the immediate future, given the uncertainties over the negotiations over a final Brexit deal. Both sets of US yield betas suggest higher-beta Canada, Australia and New Zealand are more at risk of relative underperformance versus lower-beta France, Germany and Japan. In terms of government bond country allocation, we recommend reducing exposure to the former group and increasing allocations to the latter group. Bottom Line: Within global government bond portfolios, downgrade the US to underweight. Favor countries that have lower sensitivity to rising US Treasury yields, especially those with central banks that are likely to be more dovish than the Fed in the next few years. That means increasing allocations to core Europe and Japan, while reducing exposure to “higher-beta” Canada and Australia.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Ryan Swift US Bond Strategist rswift@bcaresearch.com III. Indicators And Reference Charts The S&P 500 is experiencing its second correction in the past two months. The market looks even more fragile than it did in September. COVID-19 is heating up fast enough that lockdowns are re-emerging globally, the odds of an imminent fiscal deal have cratered to a near-zero chance, and investors are paying more attention to the growing risk of gridlock in Washington where a Biden Presidency and a Republican Senate majority would result in temporary fiscal paralysis. In this context, the decline in the momentum of the BCA Monetary Indicator, the elevated reading of our Speculation Indicator and the overvaluation of the stock market create the perfect cocktail for a dangerous few weeks. The longer we live in uncertainty regarding the elections’ result, the worse the market will fare. Short-term indicators confirm that equities are likely to remain under downward pressure in the coming weeks. Both the proportion of NYSE stocks above their 30-week and 10-week moving averages are still deteriorating after forming negative divergences with the S&P 500. They are also nowhere near levels consistent with a solid floor under the market. Moreover, our Intermediate Equity Indicator and the S&P 500 as a deviation from its 200-day moving average have rolled-over after reaching extremely overbought levels. Finally, both the poor performance of EM stocks as well as the underperformance of the Baltic Dry index and global chemical stocks relative to bond prices and the VIX indicate that cyclical assets could suffer from a wave of growth disappointment. Despite these short-term headwinds, the main pillar supporting the rally remains intact: global monetary conditions are highly accommodative. Moreover, the economic and financial risks created by the tepidity of fiscal support in recent months is self-limiting. As the economy progressively teeters toward a second leg of the recession, the pressure will rise for policymakers to spend generously once again to support their nations. Our cyclical indicators confirm the positive backdrop for stocks. Our Monetary Indicator remains at the top of its pre-COVID-19 distribution, which will put a natural floor under stocks, even if its recent deterioration is consistent with a market correction. Moreover, our Revealed Preference Indicator continues to flash a buy signal for stocks. Additionally, the BCA Composite Sentiment Indicator stands toward the middle of its historical distribution and the VIX has not hit the extremely compressed levels that normally precede major cyclical tops in the S&P 500. When weighing the short-term negative forces against the cyclical positives, we expect the S&P 500 to find a floor between 3000 and 3100. At this level, the froth highlighted by our Speculation Indicator will have dissipated.  The bond market’s dynamics are interesting. Despite the violent sell-off in equities, Treasury yields are not declining much. Bonds are too expensive and with short-term rates near their lower bound, Treasurys are losing their ability to hedge equity risk in portfolios. Moreover, the bond market seems to understand that any recession will encourage additional fiscal profligacy, which puts a floor under yields. These dynamics suggest that once equities stabilize, yields could start rising meaningfully. Finally, the dollar continues its sideways correction. However, as risk aversion rises and global growth deteriorates, the dollar is likely to catch further upside in the near term, especially as it has not fully worked out this summer’s oversold conditions. Moreover, the dollar is a momentum currency. Thus, once its start to turn around, its rally is likely to be more powerful than most expect, which will put additional downward pressures on commodity prices. Consequently, it is too early to start selling the USD again or to bottom fish natural resources. EQUITIES: Chart III-1US Equity Indicators Chart III-2Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators   Chart III-4Revealed Preference Indicator Chart III-5US Stock Market Valuation Chart III-6US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations Chart III-10Yield Curve Slopes Chart III-11Selected US Bond Yields Chart III-1210-Year Treasury Yield ComponentsChart III-13US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets   CURRENCIES: Chart III-16US Dollar And PPP Chart III-17US Dollar And Indicator Chart III-18US Dollar Fundamentals Chart III-19Japanese Yen Technicals Chart III-20Euro Technicals Chart III-21Euro/Yen Technicals Chart III-22Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Chart III-24Commodity Prices Chart III-25Commodity Prices Chart III-26Commodity Sentiment Chart III-27Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop Chart III-29US Macro Snapshot Chart III-30US Growth Outlook Chart III-31US Cyclical Spending Chart III-32US Labor Market Chart III-33US Consumption Chart III-34US Housing Chart III-35US Debt And Deleveraging   Chart III-36US Financial Conditions Chart III-37Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China   Mathieu Savary Vice President The Bank Credit Analyst   Footnotes 1 Please see The Bank Credit Analyst Special Report "Labor Strikes Back," dated February 27, 2020, available at bca.bcaresearch.com 2 High odds of staying in the income decile of your parents. 3 Please see Geopolitical Strategy Webcast "Geopolitical Alpha In 2020-21," dated October 21, 2020. Marko also recently published a book "Geopolitical Alpha." 4 Please see US Equity Strategy Weekly Report "Vigilantes Gone Missing?" dated October 26, 2020, available at uses.bcaresearch.com 5 http://www.crfb.org/papers/cost-trump-and-biden-campaign-plans 6 https://www.moodysanalytics.com/-/media/article/2020/the-macroeconomic-consequences-trump-vs-biden.pdf 7 Please see BCA Research Geopolitical Strategy Special Report, “Introducing Our Quantitative US Senate Election Model”, dated October 16, 2020, available at gps.bcaresearch.com 8 For more details on this recommended steepener trade please see US Bond Strategy Weekly Report, “Positioning For Reflation And Avoiding Deflation”, dated August 11, 2020, available at usbs.bcaresearch.com 9 For more details on our Adaptive Expectations Model please see US Bond Strategy Weekly Report, “How Are Inflation Expectations Adapting?”, dated February 11, 2020, available at usbs.bcaresearch.com 10 For a detailed look at the implications of the Fed’s policy shift please see US Bond Strategy / Global Fixed Income Strategy Special Report, “A New Dawn For US Monetary Policy”, dated September 1, 2020, available at usbs.bcaresearch.com

Highlights Most sentiment and technical indicators suggest the dollar is undergoing a countertrend bounce rather than entering a new bull market. However, the internal dynamics of financial markets remain short-term constructive for the DXY. The DXY could rise to 96 before working off oversold conditions. Stay short USD/JPY as a core holding. Look to rebuy a basket of Scandinavian currencies versus the USD and EUR at a trigger point of -2%. Go long sterling if it drops to 1.25. Remain short EUR/GBP. Feature Chart I-1The Dollar Is A Counter-Cyclical Currency The world remains dominated by the reflation trade. The equity market downdraft this past March and the subsequent recovery since April has been a mirror image of the rise and fall of the dollar (Chart I-1). This suggests that at a minimum, the Federal Reserve’s actions and Washington’s policy decisions have served as important pillars in the global economic recovery. A falling dollar tends to reflate the global economy, so it is important to gauge whether the recent bounce is technical in nature or at risk of a more meaningful increase. From an investment perspective, the economic outlook as we enter the final stretch of 2020 is as uncertain as ever. Factors such as the potential for renewed lockdowns, a fiscal cliff in the US, political uncertainty due to Brexit, and the possibility of a contested US election all make for a very complex decision tree. As investors try to decipher the end game, we turn to the internal dynamics of financial markets for a more sober view. Sentiment and technical indicators make up an important component of our currency framework, and are usually good at gauging important shifts in financial markets. Given market action over the past few weeks, we are reviewing a few of these key indicators to help guide currency strategy into year-end and beyond. The Signal From Currency Markets The message from our currency market indicators suggests a technical bounce in the dollar rather than a renewed bear market. The exchange rate that best signals whether we are in a reflationary/deflationary environment is the AUD/JPY rate.  Chart I-2DXY Is Testing Strong Resistance From a broad perspective, the DXY index was oversold, having broken below key support levels this year. More recently, the bounce in the DXY index has brought it a nudge above the upward-sloping trend line, which had defined the bull market since the 2011 lows (Chart I-2). A significant bounce from current levels will be worrisome. More likely, the dollar will churn near current levels before resuming its downtrend. In other words, we expect that, going forward, this upward-sloped line will act as powerful overhead resistance. The exchange rate that best signals whether we are in a reflationary/deflationary environment is the AUD/JPY rate (Chart I-3). Since the Great Recession, the yen has been the best performer during equity drawdowns, while the Aussie has been the worst. As a result, the AUD/JPY cross has consistently bottomed at the key support zone of 72-74. This defensive line notably held during the European debt crisis, China’s industrial recession, and the global trade war. The frontier was clearly breached during the March drawdown this year, but we have since re-entered the safe zone (Chart I-4). Going forward, a break below 72 will be worrisome. Looking at the intra-day charts, we see a clear pattern of lower highs and lower lows since the September 10th peak. That said, speculators are still short the cross, suggesting that the level of complacency going into the February equity market drawdown is not there today (Chart I-4, bottom panel). Chart I-3The Reflation Trade Chart I-4AUD/JPY: Watch The 72-24 Zone   High-beta carry currencies such as the RUB, ZAR, MXN, and BRL have been rather weak, even if they are still holding above their lows. These currencies are usually good at sniffing out a change in the investment landscape, specifically one becoming fertile for carry trades. Carry trades usually do well when US yields are low and the global growth environment is improving (Chart I-5). The message so far is that the drop in U.S. bond yields may not have been sufficient to make these currencies attractive again. This is confirmed by the performance of the Deutsche Bank carry ETF, DBV, which has been struggling to recover amid very low rates (Chart I-6). Chart I-5Carry Trades Are Lagging Chart I-6Carry Trade ETFs Have Underperformed Speculators are very short the dollar. Whenever the percentage of leveraged funds and overall speculators that are short the dollar is at or below 20%, a meaningful rally ensues (Chart I-7). However, because the dollar is a momentum currency, reversion-to-the-mean strategies work in the short term but not so much longer term. The dollar advance/decline line remains well below its 200-day moving average. Meanwhile, there is a death-cross formation between the 200-day and 400-day moving averages. This is a very bearish technical profile (Chart I-8). We cannot rule out rallies toward the 200-day moving average, but for now we remain well below this danger zone. Chart I-7Rising Number Of Dollar Bears Chart I-8A Cyclical Bear Market Finally, currency volatility is rising from very depressed levels. Usually, low currency volatility is a sign of complacency among traders and investors, while higher volatility signals a more balanced and healthy market rotation. Over the last three episodes where volatility rose from these oversold levels, the dollar soared and pro-cyclical currencies suffered severe losses. For example, the most significant episodes were 1997-1998, 2007-2008, and 2014-2015 (Chart I-9). The one difference this time around is that the dollar is expensive, while it was very cheap during previous riot points. This argues for a technical bounce, rather than a renewed bull market. Chart I-9Currency Volatility Has Spiked In a nutshell, the message from technical indicators is that the bounce in the dollar was to be expected. However, we are monitoring a few worrisome developments. First, the consensus is overwhelmingly bearish on the dollar, which could make this bounce advance much further than most expect. Second, spikes in volatility, especially as the equity market corrects, are traditionally dollar bullish. The Signal From Commodity Markets Commodity prices hold a special place as FX market indicators, since they are both driven by final demand and financial speculation. Over the years, we have found that the internal dynamics of commodity prices usually send key signals for underlying FX market trends. Overall, the signals are also mixed: The copper-to-gold ratio has bottomed and is heading higher from deeply oversold levels. Together with the stabilization in government bond yields, it signifies that the liquidity-to-growth transmission mechanism might be working. This is usually dollar bearish, as rising global growth leads to capital outflows from the US (Chart I-10). The Gold/Silver ratio (GSR) tends to track the US dollar, and its recent rebound is worrisome (Chart I-11). The GSR provides important information on the battleground between easing financial conditions and a pickup in economic (or manufacturing) activity. Gold benefits from plentiful liquidity and very low real rates, while silver benefits from rising industrial demand. Therefore, the GSR rallies during periods of financial stress that forces policymakers to act, and peaks as we exit a recession into a recovery. Chart I-10The Copper/Gold Ratio Leads The Dollar Chart I-11The Gold/Silver Ratio Is Rebounding We had a limit-sell order on the GSR at 75 that was triggered this week, putting our position offside by 7%. The key driver of GSR price action over the next few weeks will be silver prices. The next important technical level for silver is the $18-to-$20-per-ounce zone. This has acted as a strong overhead resistance since 2015, which should now provide strong downside support. If silver is able to stabilize around this level, it will indicate that the precious metals bull market remains intact. We eventually expect the GSR to drop toward 50. The Signal From Fixed-Income Markets The fixed-income market is a very powerful sentiment barometer for the dollar. Both cross-border flows and global allocation to FX reserves provide important information about investor preferences for the dollar. Below, we go through the indicators that we track frequently and which constitute an integral part of our framework. The bond-to-gold ratio is an important signal for the dollar, since both US Treasurys and gold are competing assets. Chart I-12Gold And Treasurys Are Competing Assets The bond-to-gold ratio is an important signal for the dollar, since both US Treasurys and gold are safe-haven assets and thus, by definition are competing assets (Chart I-12). As the Fed continues to increase the supply of bonds, the ratio of the US bond ETF (TLT)-to-gold (GLD) will be an important proxy for investor sentiment on the dollar (Chart I-13). For now, the ratio is sitting on the key 0.94 support zone. Remarkably, the ratio of the total return in US government bonds-to-gold prices has tracked the dollar pretty well since the end of the Bretton Woods system in the early ‘70s (Chart I-14). This makes it both a good short-term and long-term barometer. Chart I-13Watch The Bond-To-Gold Ratio Chart I-14Competing Assets And The Dollar Inflows into US government bonds are falling sharply, while those into gold are rising sharply (Chart I-15). With interest rates near zero and real rates deeply negative, this pattern is likely to continue in the near future. This should pressure the bond-to-gold ratio lower.   It is remarkable that in recent days investors have begun pricing even more negative real rates in the US compared to other G10 countries (Chart I-16). Again, should this materialize, this will send gold prices higher and cause further erosion in foreign bond purchases. Chart I-15Gold And USD Inflows Diverge Chart I-16Real Rate Expectations Are Relapsing Overall, the signal from fixed-income markets remain US dollar bearish.  The Signal From Equity Markets Equity market indicators continue to flag that the rally in the dollar has a bit further to go, but should remain a counter-trend bounce.  Currencies tend to move in sync with the relative performance of their equity bourses.  Chart I-17Cyclicals Have Outperformed Defensives Cyclical stocks have been underperforming defensive ones of late, but the pattern of higher lows in place since the March bottom continues to persist (Chart I-17). The dollar tends to weaken when cyclical stocks are outperforming defensive ones. This is because non-US equity markets have a much higher concentration of cyclical stocks in their bourses. Thus, whenever cyclical sectors are outperforming defensives, it is a clear sign that the marginal dollar is rotating outside of the US. Correspondingly, currencies tend to move in sync with the relative performance of their equity bourses (Chart I-18A and I-18B). So far, non-US equity markets have relapsed relative to the US, but are not yet breaking down. Earnings revisions continue to head higher across all markets. Bottom-up analysts are usually too optimistic about the level of earnings, but are generally spot on about their direction. That said, higher earnings revisions have been concentrated in the US so far, and will need to improve in other markets for the dollar bear market to resume (Chart I-19). Chart I-18ACurrencies Follow Relative Equity Performance Chart I-18BCurrencies Follow Relative Equity Performance Chart I-19V-Shape Recoveries In Earnings Revisions In a nutshell, corrections in equity markets are usually a healthy reset for the bull market to resume, but the character of this particular selloff is worth monitoring. Cyclical and value stocks that are already at historically bombed-out levels have started to underperform. This is usually dollar bullish. Whether the correction ensues or the bull market resumes, it will require a change in equity market leadership from defensives to cyclicals for the dollar bear market to resume. Investment Implications It is very difficult to gauge whether the current market shakeout will last just a few more weeks or continue into year-end. Given such a lack of clarity, our strategy is as follows: Stay long safe-haven currencies. Our preferred vehicle is the Japanese yen, which sports an attractive real rate relative to the US. Focus on relative value at the crosses rather than outright dollar bets. We are short the NZD/CAD and EUR/GBP as a play on relative fundamentals. Stick with them. We already have limit orders on a few currencies, and are adding the Nordic currency basket to this list if it drops another 2%. We initially took profits on this trade last week, when our stop loss was triggered. As Scandinavian currencies continue to fall, they are becoming more compelling buys. Chart I-20Place Stops On Short GSR At 85 We have been long petrocurrencies versus the euro, and the drop in the EUR/USD has helped hedge that trade against market volatility. That said our stop-loss of -5% was triggered amid market volatility. We are reinstating this trade today, and will be looking to rotate into USD shorts once there is more clarity on the economic front. Our short gold/long silver trade was triggered at 75, putting the position offside. For risk management purposes, we are implementing a tight stop at 85 (Chart I-20).   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies US Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data from the US have been mixed: The current account deficit widened from $111.5 billion to $170.5 billion in Q2. The preliminary Markit Manufacturing PMI increased from 53.1 to 53.5 in September while the services PMI declined from 55 to 54.6. The Michigan Consumer Sentiment Index increased from 74.1 to 78.9 in September. Existing home sales increased by 2.4% month-on-month in August. Initial jobless claims increased by 840K for the week ending on September 19. The DXY index appreciated by 1.8% this week amid an equity market correction. While the risk-off sentiment provides a positive backdrop for the US dollar, rising twin deficits and unfavorable real rates both suggest a weaker dollar in the long term. Meanwhile, any incoming positive news on the vaccine will support cyclical currencies against the US dollar.   Report Links: Addressing Client Questions - September 4, 2020 A Simple Framework For Currencies - July 17, 2020 DXY: False Breakdown Or Cyclical Bear Market? - June 5, 2020   The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data from the euro area have been mostly generally constructive: The current account surplus narrowed from €20.7 billion to €16.6 billion on a seasonally-adjusted basis in July. While the preliminary Markit Manufacturing PMI increased from 51.7 to 53.7 in September, the services PMI dropped from 50.5 to 47.6. Consumer confidence marginally increased from -14.7 to -13.9 in September. The German Ifo Business Climate index rose to 93.4 in September. The expectations component has broken above pre-pandemic levels. The euro declined by 1.6% this week against the US dollar. The ECB Economic Bulletin released this Thursday warned that the unemployment rate will continue to rise in the euro area as current figures are skewed by job subsides. The ECB also sees little upside in demand for consumer goods and repeated that it is ready to further adjust its policies to support the economy and boost inflation.   Report Links: Addressing Client Questions - September 4, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019   The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data from Japan have been positive: The manufacturing PMI was largely unchanged at 47.3 in September. The services PMI ticked up from 45 to 45.6. The All Industry Activity Index increased by 1.3% month-on-month in July. The Japanese yen depreciated by 1% against the US dollar this week. The latest BoJ Monetary Policy Meeting Minutes released on Thursday expects economic activity to pick up in the second half of 2020 through pent-up demand and supported by accommodative monetary policies, but it also warned about a slower recovery in the event of an upturn in COVID cases. Moreover, the Minutes said that core inflation is likely to be negative in Japan for now. Japan’s higher real rates make the yen an attractive safe-haven hedge.   Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020   British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data from the UK have been mixed: The Markit Manufacturing PMI declined from 55.2 to 54.3 in September. The services PMI also dropped from 58.8 to 55.1. Retail sales increased by 2.8% year-on-year in August. House prices increased by 5% year-on-year in September. The British pound plunged by 1.9% against the US dollar this week amid broad USD strength. Besides global synchronized risks, the internal risk from Brexit uncertainties still poses a big threat to the British pound. That said, the pound is still undervalued at current levels and its year-to-date performance lags behind those of other risky G10 currencies. The pound is poised to rebound with positive vaccine and Brexit news.   Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019   Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data from Australia have been mostly positive: The manufacturing PMI increased from 53.6 to 55.5 in September. The services PMI also ticked up from 49 to 50. The ANZ Consumer Confidence index increased from 92.4 to 93.5 for the week ending on September 20. Retail sales declined by 4.2% month-on-month in August. The Australian dollar dropped by 4% against the US dollar this week, only slightly above the pre-crisis level. We continue to favor the Australian dollar due to lower domestic COVID cases and effective measures for containing the virus. Moreover, China’s data continues to surprise to the upside, which bodes well for the Australian dollar.    Report Links: An Update On The Australian Dollar - September 18, 2020 On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019   New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data from New Zealand have been negative: Exports declined from NZ$5 billion to NZ$4.4 billion in August, while imports increased from NZ$4.6 billion to NZ$4.8 billion. The trade balance shifted from a positive NZ$447 million to a deficit of NZ$353 million. The New Zealand dollar plunged by 3.8% against the US dollar this week. On Wednesday, the RBNZ held its interest rate at 0.25%, but warned that the economy needs further support and implied further easing. The rising possibility of negative interest rates in New Zealand would hurt the kiwi especially against the Aussie dollar. Moreover, New Zealand’s services trade surplus evaporated as tourism continues to suffer. We will go long AUD/NZD at 1.05.   Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019   Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data from Canada have been positive: Retail sales increased by 1.1% month-on-month in August. New housing prices increased by 2.1% year-on-year in August. Bloomberg Nanos Confidence edged up from 52.9 to 53.1 for the week ending on September 18. The Canadian dollar fell by 1.2% against the US dollar this week. Both retail sales and the housing market have been quite resilient so far, providing support for the Canadian dollar. We are long the Canadian dollar against the New Zealand dollar. Stay with it.   Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020   Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 There have been scant data from Switzerland this week: Total sight deposit declined from CHF 704.1 billion to CHF 703.9 billion for the week ending on September 18. The Swiss franc fell by 1.4% against the US dollar this week. On Thursday, the SNB kept its interest rate unchanged at -0.75% and warned of a longer coronavirus impact on economic activity. We like the Swiss franc as a safe-haven hedge especially during a second COVID-19 wave. Moreover, if the October US Treasury Report lists Switzerland as a currency manipulator, it will limit downward pressure on the Swiss franc against the US dollar.     Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020   Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 There is no significant data from Norway this week. The Norwegian krone dropped by 2.8% against the US dollar this week. The Norges Bank held its key policy interest rate on hold at a record low 0% on Thursday, as widely expected, and said no rate hike is likely within two years. That said, with core inflation at 3.7% year-on-year in August, it’s unlikely that the Norges Bank will further lower rates into negative territory. Our NOK/USD and NOK/EUR trades from the long Nordic basket were stopped out last week with profits of 18.4% and 9.5%, respectively. We continue to like the Norwegian krone in the long term.   Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 ​​​​​​​ Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 There is no significant data from Sweden this week. The Swedish krona fell by 3.2% against the US dollar this week. On Tuesday, the Riksbank kept its interest rate unchanged at 0% and implied that the rate will likely remain unchanged at least through late 2023. However, the Bank is also ready to further lower the repo rate if necessary. The Swedish krona remains one of our favorite procyclical currencies among the G10 universe supported by its cheap valuation.   Kelly Zhong Research Analyst   Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 ​​​​​​​​​​​​​​ Footnotes Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The dollar is on the verge of a significant breakdown. If the DXY punches through 94, it will likely mark the beginning of a structural bear market. The most recent catalyst – fiscal support in the euro zone – has been good news on the “anti-dollar” front. Agreement on the EU recovery fund has underscored a powerful centripetal force for the euro. Because it is a reserve currency, a breakdown in the dollar will amplify the global liquidity surge. This will lead to a self-reinforcing spiral of better global growth, and a weaker dollar. Our long Scandinavian currency basket and long silver versus gold positions have benefitted tremendously from the shift in sentiment. Stick with them. While our technical indicators are flagging the dollar as oversold, any bounce from current levels should be shorted.  Our FX model remains dollar bearish, and is recommending shorting the DXY for the month of August. Feature Chart I-1On A Precipice The DXY index is punching below key support levels and on the verge of a significant multi-year decline. Up until March, the dollar was trading in a narrow band (Chart I-1). With that support now breached, the next key test for the DXY index will be the 93-94 zone, defined by the upward-sloping trend line, in place since the 2011 lows. As the breakdown becomes more broad-based, especially vis-a-vis emerging market currencies, this will cement the transition from easing financial conditions to improving global growth. Our trade basket has benefitted significantly from the shift in market sentiment, especially being long the NOK, the SEK and silver relative to gold. As Chart I-2 shows, while gold and the safe-haven currencies remain this year’s frontrunners, the more industrial metals such as silver and platinum will likely take over the baton by year end. Within the G10 universe, cyclical currencies such as the Australian dollar and the Norwegian krone are now in the technical definition of a bull market. Such a rotation usually signals a genuine and potentially meaningful breakdown in the dollar. Chart I-2The Great FX Rotation Our trade basket has benefitted significantly from the shift in market sentiment, especially being long the NOK, the SEK and silver relative to gold.  Technical indicators suggest the dollar is likely to consolidate losses in the weeks ahead. Our intermediate-term indicator is in the lower decile of its range, and speculators are very short the cross (see US dollar section on page 14). That said, any bounce should be used as an opportunity to establish fresh short positions, contrary to the “buy-on-the-dip” strategy that has worked well over the last decade.  DXY Breakdown: What Has Changed? US dollar weakness has been driven by three interrelated factors: Non-US economies that were initially hit by COVID-19 are well into their reopening phases. Meanwhile, new infections in the US are proving rather sticky. As a result, economic momentum is higher outside the US. This partly explains why the euro is outperforming both the US dollar and the yen (Chart I-3). Money velocity is rising faster outside the US, suggesting animal spirits are being rekindled at a faster pace abroad (Chart I-4). This is evident in capital flows, where some non-US markets have started to outperform. In the classical equation MV=PQ,1 a rise in M has historically been accompanied by a collapse in V, suggesting the economy remained in a liquidity trap. With the fiscal spending spigots now open almost everywhere, a rise in both M and V will be explosive for nominal output. Chart I-3Positive COVID-19 Trends For Europe Chart I-4Money Velocity Outside The US There was significant progress towards a European fiscal union this week, with leaders agreeing to a €750 billion recovery fund. Assuming the agreement is ratified, this will underscore a powerful centripetal force for the common-currency union. As the “anti-dollar,” this is positive for the euro (and negative for the greenback). More on this later. The US economy had been relatively resilient compared to the rest of the world, at least until late. This was in part driven by a late start to state-wide shutdowns. With various US municipalities and states now reversing reopening plans, economic activity abroad is now improving relative to the US. Chart I-5 shows the economic surprise index between the Eurozone and the US is inflecting sharply higher from very depressed levels. Historically, this has usually put a floor under the euro. Similarly, G10 PMIs have bottomed relative to the US. These trends should continue in the months ahead. Chart I-5EUR/USD And Relative Growth How High Can EUR/USD Rise? Agreement on the EU recovery fund was a historic event, not due to the size of the package but because of revealed preferences toward euro membership. For over two decades, the standard dilemma plaguing the euro area was that centralized monetary policy was never a panacea for desynchronized business cycles.2 The lack of fiscal transfers between member nations amplified this problem. With Italian and Spanish bond yields now collapsing towards those in the core, liquidity is flowing to where it is most needed, significantly curtailing euro break-up risk. The key components of the agreement are €360 billion in the form of loans and €390 billion in the form of grants. The money will be borrowed via bonds issued by the European Commission, with maturities of three to 30 years. Repayment will not be due until 2027. The most important component of the deal, the grants, is a de facto fiscal transfer. Going forward, the next catalyst for euro strength must be growth differentials between the euro zone and the US. This will translate into an improvement in the equilibrium rate of interest between the two blocs (Chart I-6). This is quite plausible in a post-COVID-19 world. As a relatively closed economy, the US has tended to have a higher services component to GDP. However, the service sector has been hit much harder by the pandemic due to social distancing measures that will likely remain in place for a while. A more drawn-out services recovery raises the prospect that countries geared more towards manufacturing, such as Europe, Japan and China, could experience better growth (Chart I-7). Chart I-6EUR/USD And The Neutral Rate Chart I-7Service Industries Could Stay Weak For A While Chart I-8The European Periphery Is Competitive Again Internally within the euro zone, a powerful adjustment has already occurred. Unit labor costs in Greece, Ireland, Portugal and Spain are well off their peak. This has effectively eliminated the competitiveness gap with the core that had accumulated over the previous two decades (Chart I-8). Italy remains saddled with a rigid and less-productive workforce, but overall adjustments have still come a long way in plugging a key fissure undermining the common-currency area. The euro tends to be largely driven by pro-cyclical flows. Fortunately for investors, European equities, especially those in the periphery, remain unloved, given they are trading at very cheap multiples. Part of the reason is that most Eurozone bourses are heavy in cyclical stocks that are well into a 10-year relative bear market.3  A re-rating of cyclical stocks, especially banks and energy, relative to defensives could be the catalyst that carries the next leg of the euro rally. This could push the EUR/USD towards 1.20. As higher-beta, the Scandinavian currencies will also benefit. For now, most analysts remain very pessimistic about European profits relative to those in the US, but that could change if the dollar enters a structural bear market (Chart I-9). Chart I-9Relative Profit Revisions Lead EUR/USD Cyclical Or Structural Move? If the DXY punches through 94, it will likely mark the beginning of a structural bear market.  If the DXY punches through 94, it will likely mark the beginning of a structural bear market. The dollar tends to run in long cycles, driven by fundamentals but also confidence. In our report last week, we suggested three indicators for gauging a shift in confidence. The total return of US bonds versus gold: Gold and US Treasurys are competing assets (Chart I-10), with the dollar being the key arbiter, as we argued last week. The TLT/GLD ratio has dropped from over 1.16 to 0.96, putting it at the precipice of bear-market territory. The USD/CNY exchange rate: Tensions are flaring up between the US and China, with the latest being the US government’s closure of China’s Houston consulate. Yet USD/CNY is still holding around 7. As the key arbiter between the dollar and emerging market currencies, a firm yuan limits upward pressure on the greenback. The gold-to-silver ratio (GSR): This correlates well with the dollar, and has absolutely collapsed (Chart I-11). Given similar moves in gold versus copper and oil, it is fair to assume that the global economy is not in a liquidity trap. Chart I-10Gold And Treasurys Are Competing Assets Chart I-11The Gold-To-Silver Ratio Has Collapsed The more important point is that there is a nascent, concerted push by both institutional investors and central banks to diversify out of dollar assets: The S&P 500 usually moves inversely to gold, but both have been moving in sync since the March lows (Chart I-12). This suggests investors have been using gold rather than US bonds to hedge their equity long positions. The dollar proved to be the best safe-haven asset during the March drawdown. With the Federal Reserve having flooded the system with dollars, gold (and precious metals) are the next logical choice. Since 2014, central banks have been aggressively diversifying out of their dollar holdings. This is not only evident in the official TIC data that continues to show foreign officials are selling Treasurys, but within IMF reserve data well. Part of these flows have gone into other currencies, especially the yen, but a huge portion has been to gold (Chart I-13). This has been driven by emerging market countries such as Russia and China, the same concerns in the middle of geopolitical confrontations with the US. Chart I-12Gold And The S&P 500 Are Moving Together Chart I-13Central Banks Are Loading Their Gold Vaults Within our service (and together with our Commodity & Energy colleagues), we have been highlighting that precious metals will be a huge beneficiary from the Fed’s reflationary efforts, even though they are overbought. As a hedged bet, we have been long silver versus gold, a trade that continues to perform well.   As the gold trade becomes crowded and demand for diversification from fiat money remains strong, silver and platinum could be the outperformers.  Chart 14 shows that precious metals such as silver and platinum are much cheaper from a historical perspective. As the gold trade becomes crowded and demand for diversification from fiat money remains strong, silver and platinum could be the outperformers. Chart I-14Silver And Platinum Remain Relatively Cheap In a nutshell, remain long silver, SEK, NOK and petrocurrencies. Currency traders can also add platinum to the list. These top picks will continue to benefit from global reflation, dollar weakness and a breakout in the euro. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com   Currencies US Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been positive: Existing home sales surged by 20.7% in June compared with May, the highest monthly gain on record. This followed a strong increase in building permits and housing starts last week. The University of Michigan consumer sentiment declined from 78.1 to 73.2 in July, while the Chicago Fed national activity index ticked up from 3.5 to 4.1 in June. Initial jobless claims increased by 1416K for the week ended July 17th, higher than the 1307K increase the previous week. The DXY index continued to edge lower, falling by 1% this week. Our bias is that the US dollar is likely to begin a long depreciation should the global economy continue to rebound.   Report Links: A Simple Framework For Currencies - July 17, 2020 DXY: False Breakdown Or Cyclical Bear Market? - June 5, 2020 Cycles And The US Dollar - May 15, 2020   The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been mixed: The current account surplus narrowed from €14.4 billion to €7.95 billion in May. Headline inflation was flat at 0.3% year-on-year in June. Core inflation also remained at 0.8% year-on-year in June. Preliminary consumer confidence marginally fell from -14.7 to -15 in July. The euro appreciated by 1.4% against the US dollar this week, climbing to the highest level in almost two years, alongside European equities. The catalyst was the €750 billion rescue fund (around 5.5% of EU GDP) announced this Tuesday. The fact that member countries reached an agreement is encouraging for the sustainability of the euro.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019   The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mostly negative: The trade deficit narrowed from ¥601 billion to ¥424 billion in June. Exports fell by 26.2% year-on-year while imports fell by 14.4% In June. National headline CPI remained flat at 0.1% year-on-year in June, while core inflation was also unchanged at 0.4%. The Jibun Bank manufacturing PMI increased from 40.1 to 42.6 in July. The Japanese yen rose by 0.2% against the US dollar this week. In the monthly report released this Wednesday, Japan’s Cabinet Office reported improvement in 6 out of 14 economic categories, including consumer spending, exports, production and public investment. However, capital spending, corporate profits and employment remain weak due to the pandemic. That said, we are long the Japanese yen as a  safe-haven hedge.   Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020   British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the UK have been positive: The Rightmove house price index rose by 3.7% year-on-year in July, up from 2.1% the previous month. CBI industrial trends survey orders recovered from -58% to -46% in July. The British pound appreciated by 1.6% against the US dollar this week. Near-term volatility around Brexit negotiations is a negative for the pound, but it is cheap and unloved.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019   Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: Retail sales rose by 2.4% month-on-month in June, following 16.9% increase the previous month. NAB business confidence fell to -15 from -12 in Q2. The Australian dollar jumped by 2.3% against the US dollar this week. The recent RBA meeting minutes suggested that there is no need to adjust its policy measures in the current environment and reiterated that negative interest rates remain “extraordinarily unlikely”.   Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019   New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 There was scant data from New Zealand this week: The New Zealand business index surged from 37.5 to 54.1 in June. The New Zealand dollar rose by 1.8% against the US dollar this week. Following weak inflation data last week , the Westpac Economic Bulletin suggests consumer prices will remain subdued on weakened demand. This raises the prospect of further stimulus from the RBNZ.   Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019   Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been positive: Retail sales increased by 18.7% month-on-month in May. Auto sales were particularly strong. The new house price index increased by 1.3% year-on-year in June.  The Teranet/National Bank house price index rose by 5.9%. Headline inflation increased from -0.4% to 0.7% year-on-year in June, as oil prices recovered. Core inflation also rose from 1.6% to 1.8% year-on-year in June. The Canadian dollar rose by 1.3% against the US dollar this week. The inflation data were stronger than expected, led by gas, food and shelter prices. Going forward, a recovery in energy prices will be important for the performance of the CAD. In general, we like petrocurrencies.   Report Links: Currencies And The Value-Versus-Growth Debate - July 10, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been positive: The trade balance widened marginally from CHF 2.7 billion to CHF 2.8 billion in June. Exports rose by 6.9% month-on-month while imports jumped by 7.3%. Total sight deposits continued to increase from CHF 688.6 billion to CHF 691.5 billion for the week ended July 17th. The Swiss franc appreciated by 1.3% against the US dollar this week. Switzerland has seen a trade recovery in recent months. Notably, luxury goods exports like Swiss watches increased by 58.9% month-on-month in June, though well below pre-COVID-19 levels.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020   Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been positive: Exports and imports both improved in June, especially with rebounding oil prices. The trade surplus widened from NOK2.7 billion to NOK3.2 billion. The Norwegian krone appreciated by 1.3% against the US dollar this week. Our Commodity & Energy team holds the view that global fiscal stimulus to combat COVID-19 will support global oil demand. Moreover, both OPEC and the US are likely to continue production cuts. Their bias is that oil prices will continue to grind higher, which is bullish for the Norwegian krone. Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been negative: The unemployment rate rose to 9.8% in June, up from 9% the previous month and 7.2% the same month last year. The Swedish krona surged by 2% against the US dollar this week. The latest Labor Force Survey released this week showed that the labor market in Sweden continues to deteriorate. In June, employment fell by 148,000. Average hours worked per week fell by 8.4%. That said, the Swedish krona remains cheap and will benefit from a global economic recovery.   Footnotes 1Where M = money supply, V = velocity of money, P = price level and Q = output. 2Please see Foreign Exchange Strategy Weekly Report, "EUR/USD And The Neutral Rate Of Interest", dated June 14, 2019. 3Please see Foreign Exchange Strategy Special Report, "Currencies And The Value-Vs Growth Debate", dated July 10, 2020.   Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Should the DXY fail to breach below 92 in the coming months, momentum will be a risk to our short dollar positions. Another risk is valuation. The trade-weighted dollar is expensive, but not overly so. It is not especially expensive versus the euro and some commodity currencies. A post-COVID-19 world in which global economies become more closed could also hurt short dollar positions. Maintain a barbell strategy, being long a basket of the cheapest currencies (SEK and NOK) together with some safe havens (JPY). This should insulate portfolios over what could become a more volatile summer. Feature Chart I-1The Dollar And Markets The breakdown in the dollar since March is still facing some skepticism, even internally at BCA. As a reserve currency, the dollar tends to do well during periods of heightened uncertainty. With a clear risk of a second COVID-19 infection wave, and with equity markets up strongly from their lows, odds are that volatility could rise in the near term. Renewed geopolitical tensions between China and the US as well as the upcoming US presidential election are also sources of risk. Historically, the dollar has tended to rise with both increasing equity and geopolitical risk premia (Chart I-1). The key question is whether any near-term bounce in the dollar is technical in nature, or represents the resumption of the bull market. While the dollar is a countercyclical currency, it has also been in a bull market since 2011, notwithstanding the growth upcycles that took place during that period. Through a series of technical, valuation, and macroeconomic charts, we will explore the key risks to our dollar-bearish view as well as potential signposts to see if we are spot on in our thinking. The Long-Term Technical Profile Is Bullish Chart I-2The Dollar And Cycles The dollar is a momentum currency, and so tends to move in long cycles. Moreover, in recent history, these cycles have tended to last around eight to 10 years, coinciding with the NBER definition of business cycles. The dollar bear market of the 1980s entered its capitulation phase with the 1990s recession. Similarly, the dollar bull market of the late ‘90s ended with the 2001 recession. The Great Recession in 2008 and subsequently cascading crises from the Eurozone to Japan in 2010-2011 ended the bear market run in the dollar from 2001. If the past is prologue, then the pandemic recession of 2020 may also be signaling an end to the dollar’s decade-long bull run. There is also an economic reason for the decade-long run in dollar cycles. This is the time it usually takes to build and subsequently unwind imbalances in the US economy. In a closed economy, savings must equal investment. However, in open economies, investors usually require a cheaper exchange rate (or higher interest rates) to fund rising deficits, just as they require a higher IRR to fund projects with risky cash flows. This has been the story for the US dollar since the 1980s (Chart I-2). Of course, dollar transition phases can be quite volatile, and the risk to this view is that the dollar bear story could be one for 2022 rather than 2020. However, it is also noteworthy that dollar tops are generally V-shaped, while bottoms are more saucer-shaped. The reason is that the Federal Reserve is usually at the center of a dollar peak, in its decisiveness to ease monetary conditions quite aggressively. At bottoms, the dollar is typically already sufficiently cheap that it does not pose headwinds to the US economy. The pandemic recession of 2020 may also be signaling an end to the dollar’s decade-long bull run. If the DXY can easily break through  the 92-94 zone, this will technically end the bull market in place since 2011, as the powerful upward-sloping channel, in place since then, will be breached (Chart I-3). On the sentiment side of things, conditions remain bullish, which is positive from a contrarian perspective. Professional forecasters often tend to be  adaptive, with a Bloomberg survey expecting the DXY to be flat by year end, but hitting 92 only in 2022 (Chart I-4). More importantly, they tend to miss important turning points in the greenback. Chart I-3A Technical Profile For DXY Chart I-4The Dollar And Forecasters The Dollar Is Not Overly Expensive The valuation picture for the dollar is more nuanced, and is our biggest source of risk. The dollar is clearly expensive versus currencies such as the Swedish krona and Norwegian krone, but on a trade-weighted basis, the dollar is only one standard deviation above our fair-value model. This still makes the dollar pricey, but not to the extent of previous peaks, that have tended to occur around two standard deviations above fair value (Chart I-5). Our long-term fair value model has two critical inputs – the productivity gap between the US and its trading partners as well as real bond yield differentials. Rising productivity ensures a country can pursue non-inflationary growth. This lifts the neutral rate of interest in the country, raising the long-term fair value of its exchange rate. The Bloomberg survey expects the DXY to be flat by year end, but hitting 92 only in 2022. Since 2010, the productivity gap between the US and its trading partners has been flat, but there is reason to believe this gap will start to roll over. For one, fiscal largesse could crowd out private investment. But more importantly, as my colleague Ellen JingYuan He of BCA’s Emerging Market Strategy reckons, productivity gains in countries like China could start to pick up as it becomes a world leader in innovation (Chart I-6). This will allow real bond yields outside the US to remain high. Chart I-5The Dollar Is Expensive Chart I-6US Relative Productivity May Decline The key point is that valuation alone is not a sufficient catalyst for dollar short positions, which is a risk to the view. This is especially the case versus commodity currencies and the euro. That said, there are still some currencies trading below or near two standard deviations from their mean relative to the US dollar. This includes the NOK, SEK, and to a certain extent the GBP (Chart I-7). We remain long these currencies in our portfolio. Chart I-7ASome G10 Currencies Are Very Cheap Chart I-7BSome G10 Currencies Are Very Cheap   Post COVID-19 Behavior Could Be Dollar Bullish A post COVID-19 world in which global economies become more closed could hurt the bearish dollar view. This is because when global growth is rebounding, more cyclical economies benefit from this growth dividend, and as such capital tends to gravitate to their respective economies. This is aptly illustrated with consumption being a much larger share of GDP in the US compared to exports (Chart I-8). A move towards more domestic production will hurt the capital flows that have tended to dictate the dollar’s countercyclical nature. A post COVID-19 world in which global economies become more closed could hurt the bearish dollar view.  Chart I-9 shows that dollar strength throughout most of March can be partly  explained by the relative resilience of the US economy, in part driven by a late start to state-wide shutdowns. With economies outside the US now reopening, PMIs abroad have recovered at a faster pace. Once the initial snapback phase has been established, differentiation among economies will then begin Chart I-8The US Economy Will Benefit From De-Globalization Chart I-9Relative Growth And ##br##The Dollar More importantly, in a post COVID-19 world, “platform” companies that can virtually leverage their technology and expertise across borders are replacing “brick and mortar” businesses that need both shipping lanes and ports to remain open. For example, will demand for autos ever recover to pre-crisis levels, when one can video conference rather than drive for two hours to the office? In general terms, if deep value stocks cannot find a way to improve their return on capital, flows into these markets (heavily represented outside the US), will dwindle. This will be a key risk to the dollar bearish view (Chart I-10).   Chart I-10Deep Value And The Dollar That said, manufacturing renaissances do happen. Asia, for example, remains at the core of both robotic and semiconductor manufacturing, which are redefining the production landscape. And over the long term, valuations do matter – and the starting point for US equities is unfavorable. Strategy And Housekeeping We continue to recommend a barbell strategy. Hold a basket of the cheapest currencies such as the NOK, SEK, and the GBP, along with some safe havens. Our list of trades is printed on page 9. We were stopped out of our short gold/silver position and are reinstating that trade today. While gold does better than silver during market riots, the ratio is 100:1, which is the most overvalued it has been in over a century. Once retail participation gains hold of cheap silver prices, which usually occurs during latter parts of precious metal bull markets, the move could be explosive. We remain long the pound, but are respecting our stop on our short EUR/GBP position that was triggered last week. Valuation supports the pound but politics will increase near-term volatility. We are raising our limit sell to 0.92, which has provided tremendous resistance since the referendum in 2016. Finally, the correction in energy prices is providing an interesting entry point for both the NOK/SEK cross and petrocurrencies. We remain oil bulls on the back of a pickup in global demand. This should lead to the outperformance of energy stocks, benefiting inflows into the CAD, NOK, RUB, MXN, and COP.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been mostly positive: The Markit manufacturing PMI rebounded to 49.6 from 39.8 in June. The services PMI and composite PMI both increased to 46.7 and 46.8, respectively. The Chicago Fed National Activity index increased from -17.89 to 2.61 in May. Existing home sales fell by 9.7% month-on-month in May. However, new home sales surged by 16.6% month-on-month. Initial jobless claims increased by 1480K for the week ended June 19th, higher than the expected 1300K. The DXY index increased by 0.34% this week. Recent data have shown some improvement in the economy, supported by the reopening and Fed’s unprecedented relief measures. We remain cautiously bearish on the US dollar. Please refer to our front section this week for a checklist of risks to the bearish dollar view. Report Links: DXY: False Breakdown Or Cyclical Bear Market? - June 5, 2020 Cycles And The US Dollar - May 15, 2020 Capitulation? - April 3, 2020 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been mostly positive: The Markit manufacturing PMI increased from 39.4 to 46.9 in June. The services PMI increased to 47.3 from 30.5 and the composite PMI ticked up from 31.9 to 47.5. The current account surplus shrank from €27.4 billion to €14.4 billion in April. Consumer confidence slightly improved from -18.8 to -14.7 in June. The euro fell by 0.5% against the US dollar this week. The ECB decided to offer euro loans against collateral to central banks outside the euro area during the pandemic. Besides, the Eurosystem repo facility for central banks (EUREP) will remain available until the end of June 2021. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: The manufacturing PMI fell from 38.4 to 37.8 in June. The coincident index fell from 81.5 to 80.1 in April, while the leading economic index ticked up from 76.2 to 77.7. The All Industry Activity Index fell by 6.4% month-on-month in April. The Japanese yen depreciated by 0.5% against the US dollar this week. The BoJ Summary of Opinions released this week pointed out that Japan’s economy has been in an extremely severe downturn and the recovery is likely to be longer and slower. Moreover, the BoJ has expressed concerns that Japan might slip back into deflation. We are long the yen as portfolio insurance. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the UK have been positive: The Markit manufacturing PMI increased from 40.7 to 50.1 in June. The services PMI also soared from 29 to 47. Retail sales fell by 13.1% year-on-year in May. However, it increased by 12% compared to the previous month.  The British pound fell by 0.7% this week. Last week, the MPC voted unanimously to keep the current rate unchanged at 0.1%. The Committee also voted by a majority of 8-1 for the Bank to increase government bond purchases by another £100 billion, bringing the total purchases to £745 billion. However, governor Andrew Bailey also indicated in a Bloomberg Opinion article on Monday that the Bank might take measures to reduce the BoE’s swollen balance sheet, indicating the £100 billion might be the last should conditions improve. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been positive: The manufacturing PMI increased from 44 to 49.8 in June. The services PMI soared from 26.9 to 53.2, bringing the composite PMI up to 52.6 in June. The Australian dollar initially rose against the US dollar, then fell, returning flat this week. During an online panel discussion this week, the RBA Governor Lowe warned about the long-lasting impact of the COVID-19. More importantly, he said that at the current level close to 0.7, the Australian dollar is not overvalued against the US dollar, even though a lower currency would support exports and push the inflation back to target. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: Exports declined by 6.1% year-on-year to NZ$5.4 billion in May, mainly due to lower sales in logs, fish, machinery and equipment. In contrast, exports of dairy products increased by 4.5% year-on-year. Imports slumped by 25.6% year-on-year, led by lower purchases of vehicles and petroleum products. The trade surplus fell to NZ$ 1.25 billion in May from NZ$ 1.34 billion in April. However, this compares favorably with a trade deficit of NZ$ 175 million in the same month last year. The New Zealand dollar fell by 0.6% against the US dollar this week. On Wednesday, the RBNZ held its interest rate unchanged at 0.25% as widely expected and maintained its current pace of QE. However, the Bank sounded quite dovish and indicted that it is ready to further ease policy whenever needed. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been positive: Preliminary data shows that retail sales rebounded by 19.1% month-on-month in May, following a 26.4% decrease the previous month. The Canadian dollar depreciated by 0.7% against the US dollar this week. In his first speech as Bank of Canada Governor this week, Tiff Macklem warned that the recovery might be longer than expected, and indicated that the Bank needs a quick response and targeted containment to fight possible future waves of COVID-19 and another round of a broad-based shutdown. Report Links: More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 The Loonie: Upside Versus The Dollar, But Downside At The Crosses Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been positive: The ZEW expectations index rose from 31.3 to 48.7 in June. Money supply (M3) surged by 2.5% year-on-year in May. Total sight deposits increased to CHF 680.1 billion from CHF 679.5 billion for the week ended June 19th. The Swiss franc appreciated by 0.2% against the US dollar this week. The SNB Quarterly Bulletin in Q2 was released this week and it showed that while government loans have been helpful to support the economy, the declines in profit margins were exceptionally severe. Moreover, a further appreciation of the Swiss franc remains a downside risk for a small open economy like Switzerland. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been negative: The unemployment rate increased to 4.2% in April from 3.6% the previous month. The Norwegian krone fell by 1% against the US dollar this week, along with lower oil prices. Last week, the Norges Bank left its interest rate unchanged at 0% and signaled that the rates are set to remain at current levels over the next few years. Report Links: A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: Consumer confidence increased from 77.7 to 84 in June. The Swedish krona appreciated by 1.2% against the US dollar this week. As one of the few countries without strict lockdown measures, Sweden’s business sectors are showing budding signs of recovery in May and June, according to a company survey by the central bank. However, most companies believe that the recovery would take at least 9 months or longer. On another note, the Riksbank has been testing its digital currency e-krona and might be the first central bank to implement the wide use of digital currency. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The dollar is likely to churn on recent weakness before a cyclical bear market fully unfolds. The reason is that the economic landscape remains fraught with uncertainty, both politically and economically. We continue to recommend a barbell strategy. Hold a basket of the cheapest currencies such as the NOK, SEK, and GBP along with some safe havens. Watch the performance of cyclicals versus defensives and non-US markets versus the S&P 500 as important barometers for dollar downside. The EUR/USD could touch 1.16, while still staying in the confines of a structural bear market. Our FX model is more aggressive, and is recommending shorting the DXY for the month of June. Feature Chart I-1The Dollar Tries To Break Down The DXY index is punching below key support levels in an attempt to reverse the cyclical bull market in place since 2011. Our technical roadmap has been the upward-sloping channel, in place since 2018 (Chart I-1). At 96.77, the DXY index is already several ticks below the lower bound of this channel. As the breakdown becomes more broad based, especially vis-à-vis the euro, this will cement the transition from easing financial conditions to improving global growth. Cyclical currencies such as the Australian dollar and the Norwegian krone have already bounced powerfully from their March lows and have now entered the technical definition of a bull market (Chart I-2). For example, from a low of 55 cents, the Aussie is now trading at 69 cents, up 25%. As long-term dollar bears, our portfolio has benefited tremendously from this shift in market sentiment.1  Chart I-2A Report Card On Currency Performance The key question for new investors is whether the move in the dollar represents a false breakdown or the beginning of a cyclical bear market. To answer this, we are reviewing key charts and indicators to explain dollar weakness and help gauge whether it pays to enter new short positions. Explaining Dollar Weakness US dollar weakness has been driven by three interrelated factors: Non-US economies that were initially hit by COVID-19 are reopening faster. As a result, economic momentum is higher outside the US. The rise in economic momentum is supporting money velocity outside the US. In other words, animal spirits are being rekindled at a faster pace abroad. In the classical equation MV=PQ,2 a rise in both M and V can be explosive for nominal output. Higher money velocity outside the US has started to attract capital inflows. This is beginning to show up in the outperformance of non-US markets. With economies outside the US now reopening, PMIs abroad have recovered at a faster pace.  Chart I-3 shows that dollar strength throughout most of March can be partly explained by the relative resilience of the US economy, in part driven by a late start to state-wide shutdowns. This was exacerbated by a dollar liquidity shortage, as demand for US dollars abroad surged. With economies outside the US now reopening, PMIs abroad have recovered at a faster pace. As Chart I-2 illustrates, developed market currencies have fared in pecking order of the easing in lockdown measures, with the AUD outperforming the CAD, and the SEK outperforming the EUR. Prior to the onset of COVID-19, there was a pretty tight correlation between global services relative to manufacturing activity and the dollar (Chart I-4). As a relatively closed economy, the US tended to benefit when services output had the upper hand. This time around, the service sector has been hit much harder due to social distancing measures in place, but it is also likely to have a more drawn-out recovery. For example, visits to theme parks or restaurants are unlikely to retrace back to their pre-crisis peaks anytime soon. However, construction activity, especially geared towards infrastructure or residential housing, may bounce back sooner. Chart I-3A Strong Recovery Outside The US Chart I-4USD And Manufacturing Vs Services The key message is that global manufacturing activity so far is holding up better than services, and activity is picking up faster abroad. This has historically been good news for procyclical currencies. Money Velocity And The Dollar There is increasing evidence that money velocity is being supported outside the US. For global manufacturing activity to recover, it requires a rise in animal spirits to begin to capitalize on very generous financing conditions. In this respect, there is increasing evidence that money velocity is being supported outside the US. In the euro area, the velocity of money in Germany has stopped falling relative to the US. This is a marked change from anything we have seen since the European debt crisis. More importantly, the ebb and flow of ‘V’ in Germany relative to the US has mirrored the relative path of interest rates (Chart I-5). Global industrial activity remains quite subdued, but it appears that sentiment among German investors is very upbeat for the post-COVID recovery. This has usually been a good barometer for the improvement in PMIs (Chart I-6). Granted, the improvement in relative V has been driven mostly by the collapse in US money velocity. But what matters for currencies are relative trends. Once economic activity enters a full-fledged recovery, we expect US output to be hampered by the rise in the dollar over the past 18 months, while cyclical economies will be buffeted by much-cheapened currencies. This raises the prospect of much more pronounced economic vigor outside the US. Chart I-5Money Velocity Support In Europe Chart I-6Euro Area Sentiment Is Improving The ratio of the velocity of money between the US and China has tended to track the gold/silver ratio (GSR) with a tight fit (Chart I-7). A falling ratio signifies that the number of times money is changing hands in China outpaces the number in the US. This also tends to coincide with a pickup in manufacturing activity, for the simple reason that silver has more industrial uses than gold. Therefore, the recent collapse in the GSR is prescient.   Soft data confirms this trend. Both the Caixin and NBS manufacturing PMI are outperforming that in the US, and are likely to keep doing so in the coming months (Chart I-8). Chart I-7Money Velocity Support In China? Chart I-8Wide Gap Between Chinese And US Output It is important to note that while there has been some disconnect between the performance of the economy and stock prices, no such dichotomy exists in currency markets. The ratio of cyclical currencies relative to defensive ones tends to track the global PMI directionally. While this ratio is below its 2008 lows, the global PMI has bottomed at higher levels (Chart I-9). The difference can probably be explained by the fact that either domestic investors (especially retail) have been the dominant buyers of equities, and/or institutional investors have been hedging currency risk. It is true that the bounce in AUD/CHF (or other procyclical pairs) from the lows has brought it closer to technically stretched levels, and some measure of indigestion is overdue. That said, this mainly reflects mean reversion from deeply oversold levels (Chart I-10). If manufacturing activity can keep improving, and the velocity of money outside the US can pick up, this will revive capital flows into these markets, which will lead to more pronounced breakouts. Given the huge uncertainty surrounding these forecasts, we believe the risk to the greenback is currently balanced. Chart I-9Equity And Currency Markets Have Diverged Chart I-10Still Oversold Capital Flows As An Indicator The nascent upturn in a few growth indicators is also coinciding with a positive signal from equity markets. Global cyclical stocks have started to outperform defensives in recent weeks, as flows into more cyclical ETF markets are accelerating (Chart I-11). Chart I-11Inflows Into Cyclical ETFs Chart I-12Inflows Into US Assets Are Picking Up The S&P 500 has been the best performing market for a few years now, so a crucial part of the dollar call lies in international equity markets outperforming the US. Indeed, the latest data show that as recent as March, net foreign inflows into US equity markets were quite strong (Chart I-12). This might explain why the S&P 500 continued to outperform during the March drawdown. In a nutshell, the outperformance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. This applies to the euro area, commodity-producing countries, and other emerging and developed market currencies (Charts I-13A and I-13B). The catalyst will have to be rising relative returns on capital outside the US, but the starting point is also extremely attractive valuations. Chart I-13ANascent Bounce In Cyclicals Versus Defensives Chart I-13BNascent Bounce In Cyclicals Versus Defensives We recently penned a report titled “Cycles And The US Dollar,” which showed empirically that US valuations have more than fully capitalized future earning streams, especially vis-à-vis their G10 peers. That said, before a cyclical bear market can fully unfold, we are watching two key indicators for dollar downside: As the Fed continues to dilute existing bond shareholders, the ratio of the US bond ETF (TLT) to gold (GLD) will be an important proxy for investor sentiment. One of the functions of money is as a store of value, and gold remains a viable threat to the dollar (and Treasurys) in this regard. A falling ratio will suggest private investors are dumping their bond holdings in exchange for harder assets such as precious metals. Recent inflows into the GLD ETF may be signaling such a shift (Chart I-14), but it will take a clean break in this ratio below 0.95 to solidify the trend. As geopolitical tensions between US and China mount, the USD/CNY exchange rate will become the key arbiter between two dollars: one versus emerging markets and the other versus developed markets. So far, USD/CNY is holding close to cyclical highs, but a break above will put Asian currencies at risk. This will have negative implications for developed-market commodity currencies (Chart I-15). Chart I-14Gold And USD Inflows Diverge Chart I-15Tied To The Hip EUR, GBP And Housekeeping We continue to recommend a barbell strategy. Hold a basket of the cheapest currencies such as the NOK, SEK, and the GBP along with some safe havens. Being short the gold/silver ratio is also a good way to play an eventual economic recovery, with the benefit of a tremendous valuation cushion. The market certainly applauded the European Central Bank’s addition of €600 billion in bond purchases, given the fall in peripheral bond spreads. The euro also bounced on the back of two factors: Chart I-16QE And EUR/USD Even with additional stimulus, the balance sheet impulse of the Fed is still larger than that of the ECB (Chart I-16). Historically, this has favored long EUR/USD positions. The compression in peripheral spreads should boost European growth as it lowers the cost of capital for countries such as Spain and Italy. This improves debt dynamics and encourages the productive deployment of capital. Technically, the EUR/USD can rally towards 1.16 while remaining within the confines of a structural bear market (Chart I-17). Beyond this point, it will be imperative for European growth dynamics to take over the baton to support a much higher exchange rate. As we mentioned earlier, the velocity of money in Germany has stopped falling relative to the US, but relative improvement is not yet enough to warrant structural positions in EUR/USD. Our FX model is more aggressive, and is recommending shorting the DXY for the month of June. Our FX model is more aggressive, and is recommending shorting the DXY for the month of June. Since the 1980s, this three-factor model has outperformed the DXY index by a significant margin (Chart I-18). Chart I-17EUR/USD Could Touch 1.16 Chart I-18The Model Is Short DXY In June Finally, our limit-sell on EUR/GBP was triggered at 0.90 last week. While valuation favors a short position, the ramp-up in Brexit tensions is a key risk to this trade. As such, we are placing tight stops at 0.905.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies US Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been negative: Headline PCE fell from 1.3% to 0.5% year-on-year in April. Core PCE also declined from 1.7% to 1%. Personal income surged by 10.5% month-on-month in April, while personal spending decreased by 13.6%, implying a higher savings rate. Total vehicle sales increased from 8.6 million to 11 million in May. Factory orders fell by 13% month-on-month in April. The trade deficit widened from $42.3 billion to $49.4 billion in April. Initial jobless claims increased by 1877K for the week ended May 29th. The DXY index fell by 1.1% this week, reflecting cautiously positive sentiment as many countries started to ease lockdown measures.   Report Links: Cycles And The US Dollar - May 15, 2020 Capitulation? - April 3, 2020 The Dollar Funding Crisis - March 19, 2020   The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been negative: Headline inflation fell from 0.3% to 0.1% year-on-year in May, while core inflation was unchanged at 0.9%. The unemployment rate increased from 7.1% to 7.3% in April. The Markit manufacturing PMI slightly fell from 39.5 to 39.4 in May, while the services PMI increased from 28.7 to 30.5. Retail sales plunged by 19.6% year-on-year in April, following an 8.8% decline the previous month. EUR/USD appreciated by 1.4% this week. On Thursday, the ECB kept key interest rates unchanged, while announcing a further 600 billion euros increase of its PEPP facility, taking the total to 1.35 trillion euros. There was also an extension of the program till June 2021.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019   The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mostly negative: Construction orders plunged by 14.3% year-on-year in April. Housing starts fell by 12.9% year-on-year in April. Capital spending increased by 4.3% quarter-on-quarter in Q1. The monetary base surged by 3.9% year-on-year in May. The manufacturing PMI was unchanged at 38.4 in May, while the services PMI increased from 21.5 to 26.5. The Japanese yen fell by 1.3% against the US dollar this week. Japan lifted its nationwide state of emergency last week, however, the economy is still in deep recession as COVID-19 continues to disrupt global supply chains.   Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020   British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the UK have been mixed: The Markit manufacturing PMI slightly increased from 40.6 to 40.7 in May. The services PMI also ticked up from 27.8 to 29. Nationwide housing prices fell by 1.7% month-on-month in May. Money supply (M4) surged by 9.5% year-on-year in April. Mortgage approvals increased by 15.8K in April, down from 56K the previous month. GBP/USD increased by 1.7% this week. The Bank of England urged banks to step up no-deal Brexit plans this week, implying that there might have been a shift in the BoE’s assumptions about the outcome of ongoing talks between the UK and the European Union. That being said, we remain bullish on the pound from a valuation perspective, but are tightening our stop loss this week.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019   Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: The manufacturing index increased from 35.8 to 41.6 in May. The current account surplus increased from A$1 billion to A$8.4 billion in Q1. However, more recent trade data was less encouraging. Imports plunged by 9.8% month on month in April while exports slumped by 11.3%. The trade surplus narrowed from A$10.6 billion to A$8.8 billion. GDP grew by 1.4% year-on-year in Q1. On a quarterly basis, it fell by 0.3% compared with the last quarter in 2019.  Building permits increased by 5.7% year-on-year in April. AUD/USD appreciated remarkably by 4.5% this week. On Tuesday, the RBA kept its interest rate unchanged at 0.25%. Moreover, the RBA sounds cautiously positive in its rate statement, saying that “it is possible that the depth of the downturn will be less than earlier expected.”   Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019   New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: Terms of trade fell by 0.7% quarter-on-quarter in Q1, down from a 2.8% increase the previous quarter. It is the first fall since Q4 2018. Building permits fell by 6.5% month-on-month in April, following a 21.7% monthly decrease in March. NZD/USD increased by 4% this week. The fall in terms of trade was led by the decline in meat prices, including lamb and beef, from record levels at the end of 2019. Forestry product prices also fell by 3.4% quarterly in Q1. On a positive note, New Zealand is prepared to ease lockdown measures as there has been no new cases reported for nearly two weeks.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019   Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been negative: GDP plunged by 8.2% quarter-on-quarter in Q1. The Markit manufacturing PMI increased from 33 to 40.6 in May. Labor productivity increased by 3.4% quarterly in Q1. Imports fell from C$48 billion to C$36 billion in April. Exports also declined from C$46 billion to C$33 billion. The trade deficit widened from C$1.5 billion to C$3.3 billion.  The Canadian dollar rose by 2.2% this week, alongside oil prices. On Wednesday, the BoC kept interest rates unchanged at 0.25%. It also decided to scale back the frequency of some market operations as financing conditions have improved.   Report Links: More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 The Loonie: Upside Versus The Dollar, But Downside At The Crosses   Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been negative: KOF leading indicator fell from 59.7 to 53.2 in May. Real retail sales plunged by 20% year-on-year in April, following a 5.8% decrease the previous month. The manufacturing PMI increased from 40.7 to 42.1 in May. GDP declined by 1.3% year-on-year in Q1. On a quarter-on-quarter basis, GDP fell by 2.6% compared with Q4 2019.  Headline consumer prices kept falling by 1.3% year-on-year in May. The Swiss franc rose by 0.5% against the US dollar this week. The 2.6% quarterly decline in Switzerland’s GDP has been the most severe since 1980, mostly led by hotels and restaurants which suffered a 23.4% fall. In addition, the consistent decline in consumer prices might lead the SNB to further step up FX intervention.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020   Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 There has been scant data from Norway this week: The current account surplus increased from NOK 25 billion to NOK 66 billion in Q1. The Norwegian krone appreciated by 3.5% against the US dollar this week. Statistics Norway’s recent balance of payments report shows that the balance of goods and services surged to NOK 27 billion in Q1. Balance of income and current transfers also increased from NOK 1.9 billion to NOK 38.9 billion. Our Nordic basket against the euro and the US dollar is now 10% in the money.   Report Links: A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020   Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been negative: GDP increased by 0.4% year-on-year in Q1, down from 0.5% the previous quarter. The trade surplus increased from SEK 5.2 billion to SEK 7.6 billion in April. The manufacturing PMI increased from 36.4 to 39.2 in May. Industrial production plunged by 16.6% year-on-year in April. Manufacturing new orders also declined by 20.7% year-on-year. The Swedish krona increased by 2.5% against the US dollar this week. Sweden’s GDP grew modestly in Q1, which is better than most of its European counterparts, following its decision not to impose a full lockdown to contain the virus.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019   Footnotes 1Please see our table of trades below. 2Where M = money supply, V = velocity of money, P = price level and Q = output.   Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights When it comes to a beauty contest among currencies, the US dollar is a winner right now. Significant dollar moves tend to occur in very long cycles. When – and only when – the crisis ends will the dollar begin to surrender to significant headwinds. The transition from a stronger to weaker dollar is likely to occur in fits and starts. Watch the gold-to-bond ratio and USD/CNY exchange rate as key arbiters in timing this shift. Feature The world economy has clearly been nudged into a very deep recession. But as with other pandemics, the global economy is likely to survive this one too. As currency markets continue to fight a tug-of-war between deteriorating global growth and very easy financial conditions, it is instructive to start placing bets on the likely winners (and losers) that will emerge from this battle. Throughout the past few decades, the most powerful driver of currencies has been the relative rate of return between any two economies. After all, an exchange rate is simply a measure of relative prices between any two concerns. And as equilibrating mechanisms by definition, currencies will fluctuate to equalize rates of returns across borders. Therefore, placing bets with higher odds of success critically requires answering two questions. Which markets and/or asset classes have the highest potential rate of return? What are the key mechanisms/signals through which this value will be unlocked? The Source Of US Dollar Beauty When it comes to a beauty contest among currencies, the US dollar is clearly the fairest. In fact, the most recent Treasury International Capital (TIC) data show that inflows into US assets have been reaccelerating (Chart I-1). Remarkably, the momentum of these purchases has been driven by equities (bottom panel), as US stocks have outperformed their international peers. Even the 2017 change in the US tax code to allow for favorable capital repatriation still continues to benefit the dollar. On a rolling 12-month basis, the US has repatriated about $192 billion in net assets, or close to 1% of GDP. Chart I-11. Inflows Into US Assets Are Picking Up Supercharging this trend has been a global shortage of dollars, which has increased the international appeal of US paper. This was triggered by the Federal Reserve’s tapering of asset purchases. The Fed’s balance sheet peaked a nudge above US$4.5 trillion in early 2015 and, until recently, had been falling. This triggered a severe contraction in the U.S. monetary base (Chart I-2), and curtailing commercial banks’ excess reserves. Chart I-2A Liquidity Flush Despite the Fed’s massive liquidity injections and significant uptake of its swap program (Chart I-3), the greenback could remain well bid in the near term. We will not revisit the analysis here, but encourage clients to read our issue from last week in case they missed it.1 What we can add is that the dollar tends to thrive in uncertainty, and even with ample dollar liquidity, non-banks are still facing dollar shortages. For example, there remains a gap between the rate on the Fed’s US dollar swap lines and various measures of offshore dollar funding. Meanwhile, cross-currency basis swaps are still wide for some developed and emerging market currencies (Chart I-4).2 Chart I-3Foreign Central Banks Tap Into USD Swaps Chart I-4The Funding Crisis Has Eased Bottom Line: As a countercyclical currency, the greenback remains well bid in the near term. Historically, the dollar has tended to move in long cycles, usually 10 years, suggesting the current bull market might be nearing an end (please see Chart I-8 in the next section). This also suggests there is no need to rush into building USD shorts, should the next cycle in the dollar last a decade.  Regime Shift? When, and only when the crisis ends will the dollar begin to surrender to significant headwinds. The good news is that these headwinds continue to mount, and will eventually exert a powerful deflationary force on the greenback.  When, and only when the crisis ends will the dollar begin to surrender to significant headwinds. Starting with equity markets, expected relative returns are extremely unfavorable for US stocks. Chart I-5A – Chart I-5R shows that the equity valuation starting point is important for local-currency returns over the long term. The chart shows 10-year annualized equity relative returns, superimposed on our composite valuation indicator.3 So, in the case of the US versus Japan, the left-hand side scale shows that US equities are trading 1.5 standard deviations above their mean valuation relative to Japanese equities. The right-hand side scale shows what to expect in terms of relative returns over the next 10 years by overweighting Japanese equities relative to the US. Chart I-5A Chart I-5B Chart I-5C Chart I-5D Chart I-5E Chart I-5F Chart I-5G Chart I-5H Chart I-5I Chart I-5J Chart I-5K Chart I-5L Chart I-5M Chart I-5N Chart I-5O Chart I-5P Chart I-5Q Chart I-5R The forward P/E on MSCI US and Japan is 19.7x and 13.4x, respectively. The skew towards the US is because market participants expect US profits to keep outperforming, the greenback to keep appreciating, or a combination of the two. While this might be plausible in the short term as the fascination with FAANG stocks continues to capture investors’ imaginations, the empirical evidence is that current US valuations have more than fully capitalized future earning streams. Based on historical correlations, expected 10-year annualized returns for the MSCI US relative to Japan is -10%. Importantly, our composite valuation indicator adjusts for sector weights, so that there is no over representation of any sector in any country. So even if technology and healthcare are winners over the next decade, capital can still gravitate from the US towards other markets where these sectors are cheaper. Capital outflows will lead to a selloff in an overvalued US dollar. In fact, across our sample of 18 developed and emerging market currencies, the message remains that long-term equity capital will dry up for US assets due to expensive valuations. Therefore, the latest inflows into US equities are at risk of a Minsky moment. Such capitulation could well be the beginning of a 10-year cycle of dollar weakness. Cross-currency basis swaps are still wide for some developed and emerging market currencies. Second, the US has lost its interest rate advantage. Against an aggregate of G10 currencies, the dollar currently yields almost nil in real terms (Chart I-6). This has historically led to a softer dollar. Remarkably, even for a Japanese or German investor, negative domestic rates might no longer be a catalyst to invest in US paper, should domestic inflation continue blasting downward. The catalyst for outflows could be if the US 10-year Treasury yield hits zero, amidst the Fed adopting negative rates. Chart I-6The US Interest Rate Gap Has Vanished Chart I-710-Year Cycle Outlook For The Dollar Once that happens, new bond investors face the prospect of real losses from either higher yields and/or currency depreciation as the Fed continues to dilute existing Treasury shareholders (Chart I-7). If the Fed is set to anchor the price of money near zero for the foreseeable future, currency depreciation is the only mechanism to entice foreign investors to keep funding the US twin deficits. The US dollar does have an exorbitant privilege in that as a reserve currency, the trade deficit is settled in dollars. However, that privilege does require that the rise in foreign exchange reserves from other central banks are reinvested back into Treasurys. This allows the current account deficit (or capital account surplus) to finance the budget deficit. The bad news is that official flows into US paper have plateaued, with the likes of Beijing and other central banks continuing to destock their holdings of Treasurys (Chart I-8). Global allocation of foreign exchange reserves paints a similar picture – allocations toward the US dollar recently peaked at about 65% and have been in a downtrend since, with the void being filled by other currencies, notably gold, the British pound, the Swiss franc, and the yen. Chart I-8Diversification Away From Dollars Accelerates The key point is that for one reason or another, foreign central banks are diversifying out of dollars. Our bias is that China has been doing so to make room for the internationalization of the RMB, as well as for geopolitical reasons, similar to other countries such as Russia. This trend will be supercharged as private investors start to focus on the real prospect of very dire returns over the coming cycle. Bottom Line: Expensive valuations and low interest rates make prospective returns for US equities and fixed income unattractive. This will force private capital to require a much lower exchange rate to fund US liabilities. The RMB And Gold As Umpires Chart I-9Will TLT Outperform GLD Next Decade? The transition from a stronger to weaker dollar is likely to occur in fits and starts. For one, the dollar is a countercyclical currency and will remain strong as uncertainty continues to dominate the macro landscape. We are watching two key indicators (among many others) as signposts for when the shift is occurring: Gold-To-Bond Ratio: One of our favorite indicators for gauging ultimate downside in the dollar is the gold-to-bond ratio. Ever since the breakdown of the Bretton Woods system, gold has stood as a viable threat to dollar liabilities, capturing the ebb and flows of investor confidence in the greenback tick-for-tick. Any sign that the balance of forces are moving away from the US dollar will favor a breakout in the gold-to-bond ratio. The TLT ETF relative to the GLD ETF broke above parity earlier this year, and has since been consolidating those gains (Chart I-9). This has brought it back within the trading range in place since early 2017. A decisive move below 0.95 will be a bearish development for the greenback. RMB Exchange Rate: As the RMB continues to gain international recognition, Chinese government bonds should outperform Treasurys. It is remarkable that from 2011 up until the Fed turned dovish in 2018, Chinese government bond performance was much better than Treasurys, even as the dollar was soaring (Chart I-10). Going forward, the USD/CNY rate should continue to act a key anchor for the direction of cyclical/emerging market currencies, as we highlighted last week. A break above last year’s highs will be bearish, while it will be encouraging if the 7.0 level is breached on the downside. Chart I-10Will Treasurys Outperform RMB Bonds Next Decade? Bottom Line: Watch the bond-to-gold ratio and Chinese RMB exchange rate as key signals for the direction of the US dollar. A breakdown in the US dollar will be a key mechanism to unlock value in foreign assets.  Housekeeping Chart I-11Target 1.10 On AUD/NZD The Reserve Bank of New Zealand decided to keep rates on hold, but reinforced forward guidance by almost doubling the size of its asset purchases to NZ$60 billion, while keeping open the possibility of negative rates. This has driven the divergence between Aussie and Kiwi 10-year yields to the highest level since 2008 (Chart I-11). In a world where rates continue to fall to very low levels, the policy of yield curve control implemented by the Reserve Bank of Australia does not pack the same punch as negative interest rates. Fundamentally, three factors will support the AUD/NZD cross: First, terms-of-trade dynamics are more favorable for Australia, which is lifting the nation’s basic balance to a substantial surplus. While infrastructure investment growth in China is likely to slow from historical levels, liquefied natural gas imports should remain in a structural uptrend. China’s switch from coal to natural gas electricity generation will continue to buffet Australian export volumes. On the kiwi side of things, as food security becomes more and more important in a post COVID-19 world, agricultural exports will not enjoy the same volume boost. Stay long AUD/NZD. Second, a substantial lift to New Zealand’s labor dividend has come from immigration (Chart I-12). The recent surge in net migrant numbers is due to exit restrictions for recent entrants. Yet even as things return to normal, that labor dividend will remain low as many people rethink international travel for work. This will restrain some supply-side parts of the economy, prompting the RBNZ to keep rates lower for longer. Chart I-12Loss Of A Meaningful Tailwind For Employment Finally, the cross offers a lot of relative value – not just from an interest rate standpoint, but also on a real effective exchange rate basis.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Weekly Report, titled “Line In The Sand,” dated May 08, 2020, available at fes.bcaresearch.com. 2 Egemen Eren, Andreas Schrimpf, and Vladyslav Sushko, “US Dollar Funding Markets During The Covid-19 Crisis – The International Dimension,” BIS Bulletin (May 12, 2020). 3 Composite indicator comprised of price-to-earnings, forward price-to-earnings, price-to-cash flow, dividend yield, price-to-book, price-to-sales, Tobin's Q, and market capitalization-to-GDP. Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been negative: Nonfarm payrolls fell by 20.5 million in April. The unemployment rate soared to 14.7% from 4.4%. The labor force participation rate declined to 60.2%. However, average hourly earnings increased by 7.9% year-on-year, since most job losses were in lower-income quartiles. Headline inflation fell from 1.5% to 0.3% year-on-year in April. Core inflation declined from 2.1% to 1.4% year-on-year in April. The NFIB business optimism index fell from 96.4 to 90.9 in April. Initial jobless claims kept increasing by 22.9 million last week. The DXY index appreciated by 1.2% this week. On Tuesday, House Democrats unveiled a $3 trillion stimulus package to further aid the economy, including nearly $1 trillion for state and local governments, $200 billion fund for essential worker hazard pay, and an additional $75 billion for COVID-19 testing. Report Links: Capitulation? - April 3, 2020 The Dollar Funding Crisis - March 19, 2020 Are Competitive Devaluations Next? - March 6, 2020 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been negative: Industrial production plunged by 13% year-on-year in March. The unemployment rate in France declined from 8.1% to 7.8% in Q1. The euro depreciated by 0.5% against the US dollar this week. The ECB Economic Bulletin released this Thursday highlighted that euro area GDP could fall by between 5% and 12% this year, highlighting uncertainty around the ultimate extent of the economic fallout. More importantly, the ECB Governing Council is fully prepared to increase the size of the PEPP by as much as necessary. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: The coincident index fell from 95.4 to 90.5 in March. The leading economic index fell from 91.9 to 83.8 in March. The trade surplus narrowed from ¥1.4 trillion to ¥1.03 trillion in March. The current account surplus shrank by nearly 40% to ¥1.97 trillion. Bank lending increased by 3% year-on-year in April, up from 2% the previous month. Machine tool orders kept contracting by 48.3% year-on-year in April.  The Japanese yen fell by 0.7% against the US dollar this week. The Economy Watchers’ Survey released this week showed that the current situation index plunged from 14.2 to 7.9 in April. The outlook index also declined from 18.8 to 16.6. It also implied that the situation is likely to deteriorate further, due to the severe challenges posed by COVID-19. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the UK have been negative: GDP contracted by 1.6% year-on-year in Q1, compared with a 1.1% increase the previous quarter. Retail sales increased by 5.7% year-on-year in April, up from a 3.5% decline in March. The total trade deficit widened notably from £1.5 billion to £6.7 billion in March. Industrial production fell further by 8.2% year-on-year in March. Manufacturing production fell by 9.7% year-on-year in March. The British pound fell by 1.6% against the US dollar this week, alongside the weak Q1 GDP data. Moreover, the National Institute of Economic and Social Research (NIESR) estimates that GDP will plunge by about 25-to-30%quarterly in Q2. They also pointed out that while some activities will resume with the reopening, there is a significant risk of a second wave which could trigger a further setback in the economy. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed:  The NAB business confidence improved from -65 to -46 in April, while the business conditions index fell from -22 to -34 in April. Westpac consumer confidence ticked up from -17.7 to 16.4 in May. Employment decreased by 594K in April, down from a 5.9K increase the previous month. The unemployment rate increased from 5.2% to 6.2%, however this is well below the expected rise to 8.3%. The wage price index increased by 2.1% year-on-year in Q1. The Australian dollar fell by 1.9% against the US dollar this week. The labour force survey showed that the number of people looking for work declined significantly during the shutdown, which has been one of the main reasons why the unemployment rate did not fall as much as expected. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mixed: ANZ business confidence improved from -66.6 to -45.6 in May. Net migration increased by 4,941 in March, compared with a 4,339 increase the previous month. The New Zealand dollar fell by 2% against the US dollar this week. On Tuesday, the RBNZ kept the interest rate unchanged at 0.25%, while increasing its asset purchase programme by up to NZ$60 billion. Moreover, it implied that negative interest rates could be possible as the COVID-19 pandemic continues to disrupt the economy. We recommend holding on to long AUD/NZD positions. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been negative: Housing starts declined from 195.4K to 171.3K in April. Building permits plunged by 13.2% month-on-month in March. The unemployment rate soared to 13% from 7.8% in April. The participation rate declined to 59.8% from 63.5%. Employment decreased by 1993.8K in April, better than the expected 4000K drop, while average hourly wages increased by 10.5% year-on-year. The Canadian dollar depreciated by 0.9% against the US dollar this week. The employment loss is led by Quebec, which saw the increase of unemployment to 18.7%. Moreover, while the number of self-employed workers was little changed, there has been a large drop in total hours worked. In addition, the loss of employment was concentrated in accommodation, food services and construction. Report Links: More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 The Loonie: Upside Versus The Dollar, But Downside At The Crosses Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been negative: Producer and import prices kept declining by 4% year-on-year in April, following a 2.7% decrease in March. Sight deposit increased from CHF 663.8 billion to CHF 669.1 billion for the week ended May 8. The Swiss franc fell by 0.3% against the US dollar this week. Switzerland has entered its second phase of reopening. Schools, businesses, museums and restaurants can reopen as long as they take precautionary measures. However, as a small open economy, Switzerland is heavily dependent on exports and imports, which are curtailed in a global economic recession. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been negative: Manufacturing output fell by 3% month-on-month in March. PPI plunged by 16.1% year-on-year in April. Headline inflation increased from 0 to 0.4% in April, while core inflation soared from 2.1% to 2.8% year-on-year, led by higher food prices especially imported fruits and vegetables. The Norwegian krone initially rebounded by 2.8% against the US dollar, then gradually fell amid broad dollar strength, returning flat this week. The Norges Bank Executive Board has decided to exclude a list of Canadian oil companies from its government pension fund due to pollution concerns. Report Links: A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been negative: Headline consumer prices contracted by 0.4% year-on-year in April. The Swedish krona has been flat against the US dollar this week. The Minutes of the Monetary Policy Meeting released this week showed that the Riksbank is ready to scale up its bond purchases if conditions warrant. Last week, all bank members continued to support asset purchases of up to SEK 300 billion until this September. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The Federal Reserve’s temporary FIMA repo facility will go a long way in helping ease dollar-funding stress outside the US. However, with the duration of the lockdown highly uncertain, a liquidity crisis could rapidly evolve into a solvency one. If the containment measures prove successful by summer, then the global economy will be awash with much stimulus, which will be fertile ground for pro-cyclical currencies. However, in the event that we receive indications of a more malignant outcome, we could retest and break above the recent highs in the DXY. We assign a one-third probability to this outcome. For now, a barbell strategy is warranted. Hold a basket of the cheapest currencies, along with some safe-havens. Crude oil has approached capitulation lows, but conditions are not yet in place for a durable bottom. Stand aside on petrocurrencies for now. Feature Chart I-1The Fed's Liquidity Injections Are Working The DXY index has once again broken above the psychological 100 level. This has occurred alongside the backdrop of very generous swap lines offered by the Federal Reserve to foreign central banks, as well as a temporary repo facility for foreign and international monetary authorities (FIMA). In fact, the euro-dollar cross-currency basis swap is now in positive territory, suggesting that a key funnel for offshore dollar liquidity has now significantly widened (Chart I-1). Why then has the dollar continued to strengthen, despite a concerted effort by the Fed to flood the global system with dollars? We offer and explore three reasons: The Fed’s actions are still insufficient. The dollar crisis is evolving from a liquidity one to a solvency one. The liquidity-to-growth transmission mechanism needs time. The Fed’s Actions Are Still Insufficient The Fed’s actions so far to ease the offshore dollar funding stress have been to: Offer unlimited funding through swap lines to five major central banks at the overnight index swap + 25 basis points.1  This was effective the week of March 16. Extend the swap lines to nine more central banks, with a cap of US$60 billion and a maturity of 84 days.2 This was announced March 19. Allow FIMA account holders to temporarily exchange their Treasury securities held with the Fed for US dollars. This was announced on Tuesday. Have these actions been sufficient? For most developed market currencies, yes. Chart I-2 shows that the currencies that have been most hit in the first quarter were of the countries initially excluded from the swap agreement such as Australia, Norway and New Zealand. Since the March 19 agreement, these currencies have staged significant rallies. Chart I-2Very Few Winners In Q1 However, there are three reasons why the Fed’s actions are still insufficient. First, they are limited to only 14 central banks, and need to be expanded further. While currencies such as the Brazilian real and Mexican peso have stabilized, others like the Turkish lira or South African rand continue their freefall. In short, many emerging market central banks do not have swap agreements with the US. These are countries with huge dollar liabilities that could continue to see their currencies fall, pushing up the  aggregate dollar index. Developed market commodity currencies tend to be highly correlated to emerging market currencies (Chart I-3). There is a huge pool within the financial architecture unable to access funding through central bank swap lines.  The second reason is that the pool of Treasury securities available to swap for US dollars has shrunk significantly. This has been on the back of slowing global trade, which sapped the current account surpluses of many countries, dampening their foreign exchange reserves. Thus, while the Fed’s latest actions may prevent an international dumping of US Treasurys, it may be insufficient to completely assuage funding stresses (Chart I-4). Chart I-3Commodity Currencies Still At Risk Chart I-4A Smaller Pool Of Treasurys To Sell Finally, a recent report by the Bank of International Settlements3 showed that of the US$86 trillion in outstanding foreign exchange swaps/forwards, about 60% is among non-bank financial and other institutions. This suggests there is a huge pool within the financial architecture unable to access funding through central bank swap lines. Given that hedge funds are included in this group, this category entails a lot more credit risk than any central bank will be willing to bear (Chart I-5). Chart I-5Can The Fed Bail Out Non-Banks? Bottom Line: While the Fed’s injection of dollar liquidity has been massive and significant, access to these funds may be limited to entities that have significant credit risk. There is not much the Fed can do about this. But at the same time, it also suggests the Fed’s actions have been insufficient to quench the global thirst for dollar liquidity. From A Liquidity To A Solvency Crisis If the containment measures prove successful by summer, then the global economy will be awash with much stimulus, which will be fertile ground for pro-cyclical currencies. As a counter-cyclical currency, the dollar will buckle, lighting a fire under our favorites such as the Norwegian krone and the Swedish krona. The euro will be the most liquid beneficiary of this move. However, the DXY index has effortlessly broken above the psychological 100 level, suggesting we could catapult to new highs. When massive amounts of stimulus are injected into markets but prices keep falling (and the dollar keeps rallying), this portends a liquidity crisis morphing into a solvency one. What ensues is a liquidation phase where the only guiding signposts are technical indicators and valuation extremes. There are a few indications we could be stepping into this phase: During recessions, the dollar rally has tended to occur in two phases. The first phase prompts the US authorities to act, usually by dropping interest rates, which dampens the rally. The next phase epitomizes indiscriminate liquidation by financial markets (Chart I-6). Enter 2008. The US first introduced swap lines with a few central banks in December 2007. But from March to October 2008, the dollar soared by about 25%. This prompted the Fed to expand its swap lines to include even some emerging markets. Despite the knee-jerk fall in the dollar of 11%, we eventually made new highs by rallying 15%. While the Fed’s injection of dollar liquidity has been massive and significant, access to these funds may be limited. As the dollar rises, it takes time for economies to implode due to strong monetary and fiscal frameworks. The implosion of the euro area economy only surfaced well after the 2008 crisis. Specifically, there has been an epic rise in global nonfinancial corporate debt. As a result, credit default swaps across many countries are surging (Chart I-7). High-yield spreads are blowing out. Our bond strategists believe that even though there is value in investment-grade debt, high-yield paper remains at risk.4  Historically, whenever the default rate has breached 4% (as is the case now), a self-reinforcing feedback loop of higher refinancing rates and defaults ensues (Chart I-8). With a recovery rate that is going to be much lower than historical standards due to bloated balance sheets, this is worrisome. Chart I-6The Dollar Rally Occurs In Two Phases Chart I-7CDS Spreads Are Widening Significantly Chart I-8Large Defaults Are Ahead It is difficult to pinpoint where the epicenter of the potential default wave will be. The energy sector looks like a prime candidate, putting many commodity currencies at risk. Bottom Line: There is a non-negligible risk that the liquidity crisis evolves into a solvency one. Though this is not our base case, we assign a one-third probability to this outcome. Liquidity To Growth Transmission Channel Monetary stimulus only affects the economy with a lag, and fiscal stimulus is so far unlikely to completely plug the hole from economic disruption. This leaves currency technicals and valuation as among the only few guiding signposts towards a peak in the DXY. There is usually a significant lag between easing in offshore dollar funding costs and a respective bottom in the domestic currency (Chart I-1). The AUD/JPY cross has broken below the key support zone of 70-72. This defensive line held notably during the European debt crisis, China’s industrial recession and, more recently, the global trade war. This pins the next level of support in the 55-57 zone, on par with the recessions of 2001 and 2008. The USD/JPY is weakening again and will likely hit 100. A rising yen is usually accompanied by a dollar rally against other procyclical currencies. Outside of the Fukushima crisis, this has been a key indicator that the investment environment is becoming precarious (Chart I-9). Chart I-9The Yen Could Touch 100 Some high-beta currencies such as the USD/TRY, USD/ZAR, and USD/IDR are still in freefall. These currencies are usually good at sniffing out a change in the investment landscape, specifically one becoming perilous for carry trades. Similarly, the USD/CNY has tested and has failed to break above 7.12. This will be a key level to watch since a break above will send Asian currencies into the abyss. “Doctor” copper has failed to stage a meaningful rebound. In fact, the copper-to-gold and oil-to-gold ratios continue to head lower from oversold levels.  Whenever cyclical sectors are underperforming defensives at the same time as non-US markets underperforming US ones, this has signaled that the marginal dollar is rotating towards the US. This is usually dollar bullish (Chart I-10A and Chart I-10B). “Doctor” copper has failed to stage a meaningful rebound. In fact, the copper-to-gold and oil-to-gold ratios continue to head lower from oversold levels. This signifies impairment in the liquidity-to-growth transmission mechanism (Chart I-11). Earnings revisions continue to head lower across all markets. Chart I-10ACyclical Markets Are Not Confirming A Dollar Top Chart I-10BCyclical Markets Are Not Confirming A Dollar Top   Chart I-11Dr Copper Is Sick Bottom Line: Historically, signs of capitulation can usually be observed by paying close attention to market internals and currency technicals. While we have had some marginal improvement, we are not out of the woods yet. Portfolio Strategy Chart I-12Go Short CAD/NOK We recommend maintaining a barbell strategy – a basket of the cheapest currencies, along with some safe-havens such as the yen and Swiss franc. Overall, investors should maintain a small upward bias in the dollar in the near term. Meanwhile, short USD/JPY positions make sense. Oil plays are becoming attractive, but conditions for a durable bottom are not yet in place. The strong rebound in the NOK/SEK cross is just an unwinding of the flash crash. If the dollar and oil have been at the epicenter of these moves, then the cross is still at risk of relapsing in the near term. We were stopped out of a long position in this cross, and will discuss oil and petrocurrencies next week. That said, a short CAD/NOK position is a much safer way to express a longer-term bearish view on the dollar (Chart I-12). We are going short this cross today with a stop-loss at 7.5. Finally, the pound remains extremely cheap versus the dollar, but the rally in recent days has eroded the potential for tactical upside. We will await better opportunities to own sterling.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 These include the Bank Of Canada, Bank Of Japan, Bank Of England, European Central Bank, and the Swiss National Bank. 2 These include the Reserve Bank of Australia, the Banco Central do Brasil, the Danmarks Nationalbank (Denmark), the Bank of Korea, the Banco de Mexico, the Norges Bank, the Reserve Bank of New Zealand, the Monetary Authority of Singapore, and the Sveriges Riksbank. 3  Stefan Avdjiev, Egemen Eren and Patrick McGuire, “Dollar Funding Costs during the Covid-19 Crisis through the Lens of the FX Swap Market,” BIS Bulletin, dated April 1, 2020. 4 Please see US Bond Strategy and Global Fixed Income Strategy Joint Special Report, “Trading The US Corporate Bond Market In A Time Of Crisis,” dated March 31, 2020, available at usbs.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been negative: The University of Michigan's consumer sentiment index plunged to 89.1 in March from 101 the previous month, the fourth largest monthly decline over the past half a century. ADP employment recorded a loss of 27K jobs in total nonfarm private sector, including a 90K decrease in small businesses payroll which was offset by the 48K increase in healthcare. Initial jobless claims surged to 6.6 million for the week ended March 27. The ISM manufacturing index came in at a relatively benign 49.1, but this was boosted by supplier deliveries. The DXY index appreciated by 1.1% this week amid growing concerns over COVID-19 and disappointing data releases. Shortly after the $2 trillion coronavirus rescue package last week, President Trump is now calling for another "very big and bold" $2 trillion "Phase 4" package on infrastructure spending. Report Links: The Dollar Funding Crisis - March 19, 2020 Are Competitive Devaluations Next? - March 6, 2020 The Near-Term Bull Case For The Dollar - February 28, 2020 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been negative: The business climate indicator dropped to -0.28 from -0.06 in March, as the COVID-19 crisis deepens. The March consumer price inflation fell across the euro area: headline inflation fell from 1.2% to 0.7% year-on-year and core inflation decreased from 1.2% to 1%.  EUR/USD depreciated by 1.1% this week. Euro zone countries have until April 9 to design another stimulus package to support the economy which might consist of financial loans and a short-term work scheme. The biggest challenge being faced is that while some member countries (including France, Italy and Spain) are calling for joint debt issuance, others (including Germany and Austria) are fiercely against it. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: The jobs-to-applicants ratio dropped from 1.49 to 1.45 in February. Industrial production contracted by 4.7% year-on-year in February, down from -2.3% the previous month. Housing starts fell by 12.3% year-on-year in February.  The Japanese yen appreciated by 1.6% against the US dollar this week, supported by growing concerns over COVID-19 and a global recession. The quarterly Tankan Survey shows that the sentiment index fell to a 7-year low of -8 in Q1 among large manufacturers, and dived to 8 from 20 among non-manufacturers. Besides, the survey points to a further deterioration of confidence over the next three months. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the UK have been negative, despite some positive releases for Q4: Consumer confidence dropped from -7 to -9 in March. Markit manufacturing PMI slipped from 48 to 47.8 in March. The current account deficit narrowed from £15.9 billion to £5.6 billion in Q4. Annualized GDP growth was unchanged at 1.1% year-on-year in Q4. The British pound soared by 2% against the US dollar this week. To preserve cash during the pandemic, the BoE's Prudential Regulation Authority (PRA) suggested commercial banks to suspend dividends and buybacks until the end of this year in addition to cancelling outstanding 2019 dividends. Moreover, the PRA also expects banks not to pay any cash bonuses to senior staff. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: Consumer confidence dropped from 72.2 to 65.3 in March. Manufacturing PMI slipped from 50.1 to 49.7 in March. New home sales increased by 6.2% month-on-month in February, up from 5.7% the previous month. Building permits grew by 20% month-on-month in February. However, we expect housing activities to slow down in March. The Australian dollar fell further by 0.4% against the US dollar this week. In the minutes released this Wednesday, the RBA warned that a "very material contraction" in economic activity was ahead. While the RBA said it was not possible to provide an update of the macro forecast given the "fluidity of the situation", it also expressed concerns that the contraction might linger beyond the June quarter. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: Building permits grew by 4.7% month-on-month in February. However, business confidence plunged from -19.4 to -63.5 in March. The activity outlook index also dived from 12 to -26.7 in March. The New Zealand dollar fell by 0.8% against the US dollar this week. Similar to the BoE, the RBNZ is now restricting all locally-incorporated banks from paying dividends on ordinary shares until the economy has sufficiently recovered in order to preserve cash and support the stability of the financial system. The RBNZ is also taking measures to help support banks to lend to businesses. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been negative: Bloomberg Nanos confidence dropped from 51.3 to 46.9 for the week ended March 27. Markit manufacturing PMI fell below 50 for the first time since last September to 46.1 in March. The Canadian dollar fell by 1.2% against the US dollar this week, weighed down by the sharp decline in oil prices. The BoC lowered the overnight target rate by another 50 bps in an emergency meeting last Friday. It also joined the QE club by launching the Commercial Paper Purchase Program (CPPP) which aims to ease short-term funding stress. Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been negative: KOF leading indicator dropped from 100.9 to 92.9 in March. Total sight deposits increased from CHF 609 billion to CHF 621 billion for the week ended March 27. The manufacturing PMI plunged from 49.5 to 43.7 in March. Headline consumer prices fell by 0.5% year-on-year in March, further down from the 0.1% decline in February. The Swiss franc fell by 1.5% against the US dollar this week. The SNB is not only battling a weaker economic backdrop, but also strong demand for safe-haven currencies. While the SNB has less room to further lower interest rates, it is taking part in easing funding stress from the pandemic. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been negative: Retail sales increased by 2% month-on-month in February, up from 0.5% the previous month. Manufacturing PMI fell to 41.9 from 51.6 in March, the lowest since the Great Financial Crisis. The new orders, production and employment components all plunged below 40, while suppliers' delivery index soared to 74. The Norwegian krone rebounded by 2% against the US dollar this week, following the brutal selloff in recent weeks weighed by the sharp decline in oil prices. The Norges Bank is stepping up in currency intervention to reduce volatility including buying the krone in exchange for the US dollar. We believe there is now tremendous value in the krone once oil prices stabilize. Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been negative: Retail sales grew by 2.8% year-on-year in February. Manufacturing PMI crashed to 43.2 in March from 52.7. The Swedish krona fell by 0.5% against the US dollar this week. In the Swedish Economy Report released on Wednesday, the NIER (Swedish National Institute of Economic Research) estimates that Sweden's GDP will fall by just over 6% in the second quarter. While the NIER believes that the current central bank measures are appropriate in supporting the economy in a wave of bankruptcies and mass unemployment, Sweden has more room to act with relatively lower government debt to its advantage. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Dear clients, In addition to this short weekly report, you will also receive a Special Report penned by my colleague Jonathan LaBerge on Sweden, with implications for the SEK. I hope you will find the report both useful and insightful. In the interim, I wish safety for you and your families. Best Regards, Chester Ntonifor Highlights The lack of dollar liquidity had been a tailwind behind the dollar bull market. However, an expansion in the Federal Reserve’s balance sheet should help stem the global shortage of dollars. Ditto if there is an expansion of swap lines beyond the five major central banks. The risk is that the shortage of dollars has already begun to trigger negative feedback loops in a few countries. Until tentative signs emerge that the global economy is on better footing, expect spikes in the dollar. The caveat is that a big fiscal spending package in the US should lead to a deterioration in the current account. This will improve the offshore dollar liquidity situation. Feature The latest flare-up in risk aversion has also rotated to the offshore dollar funding market. Across G10 countries, US dollar cross-currency basis swaps - a measure of the costs to obtain greenbacks domestically - have been rising at an alarming pace. During the Federal Reserve’s emergency meeting on Sunday, swap lines were extended to five major central banks. The terms were very generous, with costs at the overnight index swap rate + 25 basis points, as well as a maturity of 84 days. However, the following day, the dollar continued its fervent rally, with the euro-US cross-currency basis swap touching -120 points (Chart 1). Chart 1A Broad-Based Funding Crisis The lack of follow through from the Fed’s liquidity injection highlights a fundamental risk to our sanguine view that the dollar should top out sooner rather than later. While we maintain this view, it has been discouraging that the DXY has broken above 100. We had anticipated a move higher on February 21, prompting us to close our long DXY position for a loss. Today, we suggest waiting for better signposts to short the greenback outright.1 US Dollar Flows The dollar remains the reserve currency of today, with the Fed at the center of the global financial architecture. The process behind dollar shortages is a simple one: Chart 2Global FX Reserve Growth Was Anemic Countries that are experiencing falling trade balances (because of a trade slowdown or trade war) will see a fall in their foreign exchange reserves. This naturally means that their supply of dollars is declining (Chart 2). Wary of seeing local dollar interest rates rise (leading to a higher dollar, and some companies going bust), central banks could sell dollars to the private sector in exchange for local currency. As a reserve currency, the US trade deficit is also settled in dollars. This naturally leads to a flow of greenbacks outside US borders. However, it also means that the current account deficit finances the budget deficit. Therefore, a falling trade surplus in exporting countries naturally means a falling deficit in the US. In order to stimulate the US economy, the authorities pursue macroeconomic policies that tend to weaken the dollar, such as lowering rates and/or running a wider fiscal deficit. The central bank helps finance this fiscal deficit via expanding the monetary base (Seigniorage). The drop in rates causes the yield curve to steepen. This incentivizes banks to lend, which in turn boosts US money supply. As the economy recovers and demand for imports (machinery, commodities, consumer goods) rises, the current account deficit widens. This leads to a renewed outflow of dollars. It is easy to see where the process can get short-circuited, especially via an external shock. If you accept the premise that the sum of the Fed’s custody holdings together with the US monetary base constitutes the root of global dollar liquidity, then it is not yet accelerating fast enough.2 Like in the past, the Fed has been quick to correct the situation: Recently, it has instituted swap lines. However, they remain inadequate for three key reasons: The swap lines should be extended from the five central banks to many countries, because Covid-19 is now a global pandemic. Not even China (along with other emerging markets) was  included in the swap agreements. The swap lines usually have terms/limits/amounts, which means that even if the domestic central bank decided to be the lender of last resort, it could still run short of dollars. Widespread fiscal measures have been announced, but this has been mostly geared towards sustaining income. Until governments unilaterally backstop airlines, shipping firms, restaurants, or any other company afflicted by the virus from going bankrupt, a negative self-reinforcing feedback loop will remain. Chart 3The Dollar As An Arbiter Of Growth We continue to recommend standing aside on the dollar until the dust has settled. Longer-term fundamentals suggest a dollar-bearish view, but until the world gets a sense that global growth is bottoming soon, the dollar uptrend remains intact (Chart 3). We continue to use internals and market fundamentals as a guide for when to time a top.3  Finally, we have been stopped out of a few trades and are tightening stops on a few. Please see this week’s trade table for a few recommendations.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com     Footnotes 1    Please see Foreign Exchange Strategy Weekly Report,  “The Near-Term Bull Case For The Dollar”, dated February 28, 2020, available at fes.bcaresearch.com. 2   Please see Foreign Exchange Strategy Weekly Report,  “Is The World Short Of Dollars?”, dated September 13, 2019, available at fes.bcaresearch.com. 3   Please see Foreign Exchange Strategy Weekly Report,  “Currency Technicals And Market Internals”, dated March 13, 2020, available at fes.bcaresearch.com. Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The near-term path for the DXY remains up. Uncertainty about the trajectory of global growth is a potent tailwind. Central bank ammunition will eventually put a floor under global growth, but it remains a powerless weapon until animal spirits are revived. The signal on when to sell the DXY will originate from the internal dynamics of financial markets. We elaborate on a few key indicators in this report. Long-yen bets remain cheap insurance against a rise in FX volatility. Remain short USD/JPY and CHF/JPY. Until recently, the CAD had proved resilient amid the recent market turmoil. With close ties to the US, the safe-haven umbrella had sheltered the CAD from the vicious downdraft in other commodity currencies. The forces of mean reversion will pressure the CAD at the crosses. We were stopped out of our long AUD/USD trade with a loss of 2.9%. The important lesson is to stand aside when markets start to deviate from fundamentals. Feature Chart I-1Mixed Messages From Bond And Currency Markets Various market participants will look at the recent market action through different lenses. Long equity investors could easily consider this to be a healthy correction necessary to sustain the bull market in stocks. After all, the S&P 500 remains 29% above its 2018 lows, making the 10% peak-to-trough decline essential to flush out stale longs. Bond investors could see the decline in yields through two lenses: 1) a goldilocks scenario where growth eventually rebounds but central banks remain accommodative or 2) a malignant scenario where the cascading resurgence of the virus outside of Wuhan, China tethers the global economy to recession. The inversion of the yield curve in the US certainly supports  scenario 2. As for currency markets, it is becoming more and more evident that pro-cyclical pairs are pricing in an Armageddon scenario (Chart I-1). It is implausible to accurately discern the collective data being discounted in financial markets, especially when the turnover of information is as fluid and rapid as today. That said, there have been a few key market signals that have been sending a consistent message that one can pay heed to. The collective assessment is to stand aside on the dollar (and risk assets) for now. The Message From Financial Markets As a countercyclical currency, the message from high frequency growth/liquidity indicators is that the path of least resistance for the DXY remains up over the next few weeks. Chart I-2Mixed Messages From Stocks And Currencies Chart I-2 shows that the rise in global stocks was already discounting an improvement in global manufacturing in an order of magnitude similar to the 2012 and 2016 episodes. However, currency markets had been discounting a much more subdued recovery (bottom panel). What has become evident in recent days in that the stock market got the story wrong, at least in terms of timing. Currently, stocks are still pricing a continued cyclical bounce in global manufacturing activity (albeit less impressive), while currency markets are pricing in outright deterioration. So directionally, both markets are sending the same message, but they disagree in terms of magnitude.  What is remarkable is that over the past few days, currency markets that were already poised for a malignant growth outcome are still selling off indiscriminately, with our favorite greed/fear barometers making fresh lows. If we had a strong certainty that global growth was on a path toward a V-shaped recovery, then currency performance could be interpreted as a sign of capitulation. But given the uncertainty now tainted around the nascent recovery we witnessed early this year it also warns against bottom-fishing at current levels. For example, peak-to-trough, the AUD/JPY, a key barometer of greed versus fear in currency markets, is down 28% and on the verge of breaking below the key 70-72 support zone. The performances of even more high-octane currency pairs such as the RUB/JPY, the ZAR/JPY or even the BRL/JPY have been dismal. As these pairs break through key support zones, it could trigger a flurry of sell orders that would reinforce the downtrend. Europe, Asia and emerging markets have a much higher concentration of cyclical stocks in their bourses compared to the US. Thus, whenever cyclical sectors are underperforming defensives at the same time that non-US markets are underperforming US ones, it is a clear sign that the marginal dollar is rotating towards the US. In a nutshell, the performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. This applies to both emerging and developed market currencies (Chart I-3). So far, this has not been the case. The backdrop could be extremely attractive valuations, but the catalyst will have to be capitulation from current sellers of cyclical stocks. The performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. Chart I-3ACapital Keeps Flowing Out Of Cyclical Markets Chart I-3BCapital Keeps Flowing Out Of Cyclical Markets The 2015-2016 roadmap was instructive on when such a capitulation might occur. Even as the market was selling off, certain cyclical sectors such as industrials started to outperform defensives ones (Chart I-4). This was a clear sign that selling pressure in cyclical sectors had been exhausted. The overall market bottomed eight months later, along with a peak in the dollar. The signal from bond yields is that non-US currencies should be outperforming. This is reflected by the fact that the drop in bond yields has been much more pronounced in the US across the curve spectrum. Currencies tend to rise with relative yields for the simple reason that markets need to make an investor indifferent between buying the currency today or in the future. If yields are higher today, the forward rate will be lower, discounting expected depreciation in the higher-yielding currency. Since the financial crisis, it has been rare that this correlation breaks down (Chart I-5). The only way one can square falling US rates with a rising dollar today is that Federal Reserve rate cuts will be most potent on the US domestic sector, helping the US consumer charge the eventual rebound in global growth. My colleague Mathieu Savary argues that this could indeed be the backdrop for the dollar over the next two-to-three years. Chart I-4Pay Heed To Subtle Divergences Chart I-5Interest Rates And The Dollar As for the near term, what is clear is that US growth continues to outperform, which is supportive of the dollar. The sharp drop in the economic surprise index for the G10 relative to the US supports this view (Chart 6). In commodity markets, the copper-to-gold and oil-to-gold ratios are breaking down along with government bond yields. This clearly signifies that the liquidity-to-growth transmission mechanism is impaired (Chart I-7). “Force majeures” are rare, so the fact that China has already issued more than 1,600 certificates covering copper, liquefied natural gas, and coal imports reveals an inherent belief that the slowdown will be genuine and meaningful. Chart I-6The US Still Has Positive Growth ##br##Surprises Chart I-7Commodity Markets Are Sending A Distress Signal Earnings revisions are heading lower across a swathe of geographies. Bottom-up analysts are usually less certain about the level of earnings but spot on about the direction (Chart I-8). Not surprisingly, the downgrades have been driven by emerging markets, meaning that return on capital will be best sought in less-cyclical bourses such as the US. Momentum-wise, being long the US dollar is becoming a captivating trade. 75% of currencies are currently falling versus the dollar. The history of this indicator is that it has usually required a move into overbought conditions before a bet on a playable reversal can be justified (Chart I-9). Chart I-8Earnings Revisions In EM Have Fallen Off A Cliff Chart I-9A Growing Consensus Of Short Dollar ##br##Trades On a cyclical horizon (over the next year), we remain dollar bears given our inherent belief that the shock from the virus will soon dissipate, and green shoots from global growth will reemerge. However, for more tactical investors, momentum currently favors the greenback. In addition to the indicators above, we are also monitoring global growth economic barometers on when to time a shift away from the DXY. On Volatility And Safe Havens The dollar is expensive across most measures of purchasing power, but less so when other fundamental factors such as interest-rate differentials and productivity trends are taken into consideration. The risk is that, as a reserve currency, the dollar rally continues unimpeded by valuation and sentiment concerns for the time being (Chart I-10). This is not our base case, but the probability of such a scenario is not zero. More importantly, currency volatility remains near record lows as the latest dollar rally simply supercharges a trend in place over the past decade (Chart I-11). Every seasoned investor does and should pay attention to low volatility. Over the last three episodes where volatility dropped to these levels, the dollar soared and pro-cyclical currencies suffered severe losses. Everyone remembers 1997-1998, 2007-2008, and 2014-2015. So far, the risk is that this time will be the same. Chart I-10The Dollar Is Expensive, But Not Excessively So Chart I-11Currency Volatility Remains ##br##Depressed Most clients acknowledge that recent US dollar purchases have been on an unhedged basis. This means as long as nominal US yields remain above those in the rest of the world, this trend can continue. That said, the prospect for real capital losses should the consensus long-dollar trade be wrong is non-negligible. The dollar has been in a bull market since 2011, but the shift in valuations has simply unwound the undervaluation gap. The dollar tends to run in long cycles, and a decisive move into much overvalued territory is possible (though again, not our base case). US Treasurys have started to outperform gold, suggesting the US dollar is becoming, at the margin, the currency of preference for safety (Chart I-12).   The gap between the USD/JPY and real rates has opened up a rare arbitrage opportunity. The yen provides valuable portfolio insurance at this economic crossroads. One of the most potent moves in rate markets has been the +135-basis-point move in favor of Japanese yields (Chart I-13). More importantly, the gap between the USD/JPY and real rates has opened up a rare arbitrage opportunity. Should a selloff in global risk assets materialize, the yen will strengthen. On the other hand, if global growth does eventually accelerate, the yen will surely weaken on its crosses but could still strengthen vis-à-vis the dollar. Chart I-12The Signal From Bonds Versus Gold Chart I-13JGBs Are Becoming Attractive This win-win situation for the yen hinges on three key pivotal developments: For most of the past five years, the Bank of Japan was one of the most aggressive central banks in terms of asset purchases. This was a huge catalyst for a downturn in the trade-weighted yen (Chart I-14). With renewed expansion of the Fed’s balance sheet, monetary policy is tightening on a relative basis in Japan. Movements in the yen are as influenced by external conditions as what is happening domestically, given Japan’s huge export sector. For example, the yen reacts very potently to moves in the VIX (Chart I-15). The yen is a very cheap currency, and the latest selloff has all but assured further depreciation into undervalued territory. As we will illustrate in an upcoming report, it pays to be contrarian when it comes to currency valuations, albeit over the longer term (Chart I-16). Chart I-14The BoJ And QE: No More Bullets Chart I-15The Yen Is Still A Risk Off Currency Chart I-16A Win-Win Dynamic For Long Yen Positions In a situation where global growth does improve, the yen will tend to weaken, given that it is usually used to fund carry trades. That said, our contention is that the yen will surely weaken at the crosses but could still strengthen versus the dollar. This is because the USD/JPY and the DXY tend to have a positive correlation, since the dollar drives the yen most of the time. More conservative investors can remain short CHF/JPY. The authorities at the Swiss National Bank must be pacing up and down over the impact of a strong currency in a deflationary world. Given that Swiss interest rates are the lowest in the G10, the CHF becomes the only tool of adjustment to inflate domestic prices. Selling the franc and loading up on US and international stocks as they correct is a foolproof way cushion the business cycle in Switzerland. Meanwhile, inflation differentials with the US have been lower in Japan compared to Switzerland, but the franc has been stronger. This suggests that, as a safe haven, the franc is incrementally more expensive than the yen. Bottom Line: The yen is the most attractive safe-haven currency at the moment. Remain short USD/JPY and CHF/JPY. We are widening our stops on both trades to account for the rise in market volatility.    Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies US Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been mostly positive: The Markit preliminary manufacturing PMI decreased to 50.8 from 51.9 in February. New home sales jumped by 7.9% month-on-month in January.  Consumer confidence increased slightly to 130.7 from 130.4 in February. Durable goods orders slipped 0.2% month-on-month while nondefense capital goods orders excluding aircraft grew 1.1% month-on-month in January. The DXY index depreciated by 1.2% this week. Markets sold off dramatically on the back of renewed fears about Covid-19. While markets are pricing in 71 basis points of easing over the next 12 months, Fed Vice Chair Clarida emphasized a wait-and-see approach. Fed inaction places a near-term bid on the dollar, though longer term, we remain bearish. Avoid outright dollar bets for now.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020   The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been positive: The Markit manufacturing PMI improved to 49.1 from 47.9 while the services PMI increased to 52.8 from 52.5 in January. This nudged the composite PMI further into expansion territory at 51.6. Core CPI came in at 1.4% year-on-year in January. Sentiment improved in the euro area this week. In February, the economic sentiment indicator increased to 103.5 from 102.6, the business climate indicator improved to -0.04 from -0.19, and the industrial confidence moved up to -6.1 from -7.    In Germany, the closely watched IFO survey bounced to 96.1, driven by the expectations component. So far, the V-shaped recovery in European manufacturing expectations appears un-derailed. The euro appreciated by 1.4% against the US dollar this week. Following the powerful upward momentum that we saw in the DXY index over the last few days, some specter of mean reversion is not a surprise. This week, President Lagarde reiterated the need for fiscal measures to combat climate change, which will also be euro-bullish beyond Covid-19.    Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mostly negative: The national CPI grew by 0.7% in January, decreasing slightly from 0.8% the previous month. More instructive will be the Tokyo CPI print released as we go to press. The Jibun Bank manufacturing PMI declined to 47.6 from 48.8 in February. The coincident index decreased to 94.1 while the leading economic index increased to 91.6 in December. The Japanese yen appreciated by 2% against the US dollar this week. As we go to press, Japan is temporarily closing all schools to temper the spread of the coronavirus. Domestically, data were weak already with the PMI weighed down by new orders and output prices. Tourism, a key source of domestic demand, has also been hit hard. As a safe-haven currency, a risk-off scenario will only trigger repatriation flows benefitting the yen.   Report Links: Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2   Recent data in the UK have been positive: The Markit manufacturing PMI increased to 51.9 from 50 while the services PMI decreased to 53.3 from 53.9 in February. That still underpinned a solid composite PMI at 53.3. The BRC shop price index declined by 0.6% year-on-year in January.   The British pound was flat against the US dollar this week. BoE deputy governor Cunliffe took a somewhat hawkish tone, stating that “there is not much monetary policy can do” in the case of a supply shock from Covid-19. Uncertainty over monetary policy, Brexit and Covid-19 are now compounding influences on pound volatility.  Our bias is a trading range for GBP-USD between 1.28-1.32 until a clear catalyst emerges.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: The value of construction work done in Q4 2019 contracted by 3% quarter-on-quarter, improving from a contraction of 7.4% the previous quarter. Private capital expenditure contracted by 2.8% quarter-on-quarter in Q4 2019, worsening from a contraction of 0.4% the previous quarter. The Australian dollar depreciated by 0.6% against the US dollar this week. Australia is more exposed to negative developments regarding Covid-19, given strong ties to China. Weak data on investment and consumption have also suppressed the Australian dollar recently. Notwithstanding, AUD/USD, now at post-crisis lows, looks deeply oversold. We were stopped out of our long AUD/USD trade for a loss of 2.9%. For risk management purposes, we are standing aside.   Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019   New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mixed: Exports decreased to NZD 4.7 billion from NZD 5.5 billion while imports were flat at NZD 5.1billion in January. The monthly trade balance was in a deficit of NZD 340 million in January.   The ANZ business confidence indicator worsened to -19.4 from -13.2 in January. Retail sales grew by 0.7% quarter-on-quarter in Q4 2019, declining from a 1.7% expansion in Q3 2019. The New Zealand dollar depreciated by 0.1% against the US dollar this week. Like its antipodean partner, New Zealand is highly exposed to the slowdown in the Chinese economy. In the short-term, tourism will be hit hard, as will other service industries. This environment will not be favorable for long NZD trades.      Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019   Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been mixed: Retail sales growth remained flat month-on-month at 0.5% in December, slowing significantly from growth of 1.1% the previous month. Wholesale sales grew by 0.9% month-on-month in December, improving from a contraction of 1.1% the previous month. The current account deficit narrowed to CAD 8.76 billion from CAD 10.86 billion in Q4 2019. We get GDP data this Friday morning, and we anticipate a nascent recovery put at risk from Covid-19.  The Canadian dollar depreciated by 0.7% against the US dollar this week. In addition to global risk-off flows, the Canadian dollar was hurt by the sharp decline in oil prices, which are now close to 2019 lows. Uncertainty has led markets to price in 52 basis points of further easing from the BoC. This will support our long EUR/CAD trade going forward.   Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies- November 8, 2019   Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 There is scant data out of Switzerland this week: The expectations component of the ZEW survey declined to 7.7 from 8.3 while the current situation component declined to 15.4 from 29.2 in February. The Swiss franc appreciated by 1.5% against the US dollar this week. This must be sending shock waves along SNB corridors. Domestic data remain weak but, as with the Japanese yen, the franc was propped up by safe-haven flows. In the near-term, expect the franc to trade more on global sentiment rather than economic fundamentals. EUR/CHF strengthened slightly over the past few days but remains close to historic lows. The SNB will be watching carefully for signs of sustained strength in the franc and will act as needed to prevent rampant appreciation.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020   Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been positive: The unemployment rate decreased to 3.9% from 4% in December.  Retail sales grew by 0.5% month-on-month in January, improving from a contraction of 2% in the previous month. The Norwegian krone depreciated by 0.7% against the US dollar this week. The petrocurrency was hurt by falling oil prices which triggered a 9.7% decline in the Oslo Bors All-Share Index this week. At 1.5%, the Norway’s policy rate is among the highest in developed markets. If the economy remains weak and there is another global easing cycle, the Norges Bank will feel the pressure. We remain short USD/NOK but acknowledge that this trade could continue to underperform in the next few days.    Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019   Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: Consumer confidence improved to 98.5 from 92.6 in February. The producer price index contracted by 0.4% year-on-year in January. The trade balance moved into a surplus of SEK 9.9 billion from a deficit of 2.3 billion. Retail sales grew by 2.7% year-on-year in January, slowing slightly from 2.8% the previous month. Capacity utilization decreased to -2.1% in Q4 2019 from 0.5% the previous quarter. The Swedish krona appreciated by 1.3% against the US dollar this week. Usually, when a currency is cheap, the undervaluation starts to show up in external balances as was the case with Sweden trade data. The key concern for the Riksbank at the moment will be the impact of the negative oil price shock on its inflation forecast as well as the impact of Covid-19 on external demand.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019   Footnotes Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades